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MONETARY THEORIES

Introduction

Money plays a distinct role in the determination of the volume of output, its production, its distribution to the factors of production and the level of consumption. Monetary Theory The study which seeks to discover and explain how the use of money in its different functions affect the production, distribution and consumption of goods.

The Printing Press Cure

Pledging for the foreseeable future to pump vast sums into banks, other financial firms, businesses and households.

Irving Fisher (1867-1947)

A mathematician turned economist from Yale. Published several highly successful mathematical textbooks.

Fishers Quantity Theory of Money

Based on the equation of exchange; what determines the purchasing power of money or its reciprocal, the level of prices. Five determinants: (1) volume of currency in circulation, (2) velocity of circulation, (3) volume of bank deposits subject to check, (4) its velocity, and (5) volume of trade. Monetary economics is the branch that handles the five regulators of purchasing power.

Fishers Equation of Exchange


MV + MV = PT; Where: M = quantity of currency; V = its velocity of circulation; M = quantity of demand deposits; V = its velocity of circulation; P = average level of prices; T = quantity of goods and services sold, with each unit being counted each time it is sold or resold Level of Prices is determined by the quantity of currency in circulation.

Fishers Quantity Theory of Money


Excessive debts led to liquidation, with the dumping of goods in the market. Falling prices of goods led to further pressure for liquidation of debts. Fluctuations in demand deposits are the greatest cause of business fluctuations.

Friedmans believes

Inflation is always and everywhere a monetary phenomenon, produced in the first instance by an unduly rapid growth in the quantity of money. The only effective way to stop inflation is to restrain the rate of growth of the quantity of money.

Milton Friedman (1912-2006)

Was a leading monetarist Economics professor at the University of Chicago

Transaction Demand for Money

Demand for Money The total amount of money balances that everyone wishes to hold for all purchases. Transaction balances Money is passed from households to firms to pay for the goods and services produced by firms; and money is passed from firms to households to pay for the factor services supplied by households to firms.

Transaction Demand for Money

The modern theory of transactions balances predicts that these costs will be less of an inhibition the higher is the rate of interest.

The Precautionary Motive

Precautionary balances Firms carry money balances for precautionary motives. The larger such balances, the greater is the degree of insurance against being unable to pay bills because of some temporary fluctuation in either receipts or disbursements.

The Speculative Motive

It emphasizes its role as a store of wealth. Speculative balances Balances held in anticipation of a fall in the price of assets.

Influence of Interest Rates on the Demand for Money

Market rate of interest reflects the opportunity cost of money holdings. The higher the rate of interest, the higher the cost of holding money and the less money will be held in transactions and precautionary purposes. Liquidity preference refers to the demand to hold assets in the form of money. The schedule relating the demand for money to the interest rate is called the liquidity preference schedule.

MONEY AND MONETARY POLICY

Function of Money

As a medium of exchange

1A

3C

To restate the role of money, money serves as a vehicle for the free flow of products to satisfy human wants since it can be exchanged with any product available in the market as a common thing of value.

2B

Money Supply

Money is a vehicle of economic activities. Money Supply consists of the following: Coins and Bills in circulation Demand deposits in Banks- intended for spending and circulated through the use of checks which are as good as money. Quasi-Money- consists of savings and time deposits.

Savings Deposits Time Deposits Deposits Substitutes- deposits in savings banks, savings and loan associations and even in credit unions.

Measures of Money Supply

The basic function of money is that it must be acceptable as a medium of exchange. M1, the first measure of money. M1 = currency circulation + demand deposits M2 , the second measure of money. It includes the concept of store of value which includes savings and time deposits sometimes called quasi-money. M2 = M1 + time + savings deposits

Total liquidator M3 , the third measure of money. These consists of debt papers or securities issued by banks, but are not deposits. It includes M2 plus deposit substitutes. M3 = M2 + deposit substitutes M4, the last measure of money. M4 = M3 + peso equivalent of dollar deposits in Foreign Currency Deposit Units (FCDU) and Offshore Banking Units (OBU)

Banks and Money Supply

The Fractional Reserve System - enables commercial banks to lend more than their reserves. - they do so by creating more demand deposits which can circulate like money in the form of checks while supported by smaller cash amount to only meet fractional cash demand.

Money Creation

Commercial banks create more money by lending more demand deposits.

Functions of the Central Bank

Has the responsibility to administer the monetary, banking and credit system of the republic as embodied in Section 2 articles of the amended Republic Act 265. That responsibility is exercised to achieve monetary objectives in consonance with the overall economic policies of the government. The objectives are as follows: 1. To maintain internal and external monetary stability in the Philippines, and to preserve the international value of the peso and its convertibility to other freely convertible currencies.

2. To foster monetary, credit and exchange conditions conducive to a balanced and sustainable growth of the economy.

Central bank regulates the magnitude and the movement of funds from sources to users.

The Confidence in Money

The Central Bank is the only authorized government entity to print money and is responsible for the proper administration of the monetary, banking and credit system of the republic to achieve monetary stability and create conditions conducive to economic development.

Short-Run Tools Affecting Money Supply

Reserve Requirements - % of deposits that must be held by a bank as vault cash or on account with the federal reserve. Rediscounting - the Central Bank can infuse money into the reserves of the banking system by buying its loan papers at rediscounted values.

P = F/ (1+r)
Where: P = Present Value F = Future Value r = Discount rate n = Number of years back from maturity to purchase

Open-market operations - buying and selling treasury bonds, notes, and bills. When the Federal Reserve sells more treasury securities than it buys: Money Supply Decreases When the Federal Reserve buys more treasury securities than it sells: Money Supply Increases

- THE

1. The study which seeks to discover and explain how the use of money in its different functions affect the production, distribution and consumption of goods. 2. A mathematician turned economist from Yale. 3. The branch that handles the five regulators of purchasing power. 4-6 Give 3 determinants to determine the level of prices. 7. He believes that The only effective way to stop inflation is to restrain the quantity of money. 8. The schedule relating the demand for money to the interest rate

9. Consists of savings and time deposits. 10. Buying and selling treasury bonds, notes, and bills. 11. Enables commercial banks to lend more than their reserves. 12. % of deposits that must be held by a bank as vault cash or on account with the federal reserve. 13. The first measure of money. 14. These consists of debt papers or securities issued by banks, but are not deposits. It includes M2 plus deposit substitutes. 15. Deposits in savings banks, savings and loan associations and even in credit unions.

1.Monetary Theory 2. Irving Fisher 3. Monetary Economics 4-6. (1) volume of currency in circulation, (2) velocity of circulation, (3) volume of bank deposits subject to check, (4) its velocity, and (5) volume of trade. 7. Milton Friedman 8. Liquidity preference schedule 9. Quasi-Money 10. Open-market operations

11. Fractional Reserve System 12. Reserve Requirements 13. M1 14. Total liquidator M3 15. Deposits substitutes