MONETARY

THEORY
WHAT IS MONETARY
THEORY?
GROUP 5
2019
INTRODUCTION

Money has major and minor

functions. Its use in any of these
capacities brings variation in the
volume and direction of business
activities

Money really 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.

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MONETARY THEORY

The study which seeks to

discover and explain how the
use of money in different
functions affect the production,
distribution and consumption of
goods.
Monetary theory is based on the
idea that a change in money
supply is the main driver of
economic activity. It argues that
central banks, which control the
levers of monetary policy, can
exert much power over
economic growth rates by 3
tinkering with the amount of
currency and other liquid
MONETARY THEORY

PRINTING PRESS CURE

Means the pledging for the
foreseeable future to push large
amount of money into banks, other
financial firms, businesses and
households.

Flooding the economy with freshly

printed money may prevent a self-
reinforcing downward curved but it
may cause trouble. It can cause
inflation.
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MONETARY THEORY

INFLATION
 In economics, inflation is a rise
in the general level of prices of
goods and services in an
economy over a period of time.
 When the general price level
rises, each unit of currency
buys fewer goods and services.
 In other words when the
purchasing power of the
currency is weak, there is an
inflation in that certain country.
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MONETARY THEORY

INFLATION
Inflation, or the fear of inflation,
could discourage foreign
investors. Provoke a disorderly
decline in the currency, sending
prices and interests rates sharply
higher.

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FISHER’S MONETARY THEORY

 a mathematician turned economist

 was a man of many projects
 published several successful
mathematical textbooks

IRVING FISHER

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FISHER’S MONETARY THEORY

Five Determinants:
1. the volume of currency in circulation
2. velocity of circulation
3. the volume of bank deposits subject to check
4. velocity
5. the volume of trade

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FISHER’S MONETARY THEORY

Fisher's equation of exchange was stated as:

MV+M'V'= PT

* where M is the quantity of currency, V is its velocity of

circulation, M' is the quantity of demand deposits, V' is its
velocity of circulation, P is the average level of prices, and T is
the quantity of goods and services sold.

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FISHER’S MONETARY THEORY

Two Reasons that deposits are normally a relatively fixed definite

multiple of currency:

 Bank reserves are kept in fixed definite ratio to bank deposits.

 Individuals, firms , and corporations maintain fairly stable
ratios between their cash transaction and their check
transactions, as well as between their currency and deposits
balances.

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FISHER’S MONETARY THEORY

To propound a cause and effect relationship between the

quantity of currency and the price level, Fisher also had to
assume that the velocity of circulation and the volume of trade
are constant.

Fisher's plan:
- we would first abandon gold coins and use only gold
certificates(paper money redeemable in gold bullions. ) The
government would vary the quantity of gold bullion it would give
or take for a paper dollar; that is, it would vary the price of gold 11
in order to maintain stability in the general price level.
FISHER’S MONETARY THEORY

Decreasing the price of gold would reduce the supply of gold

certificates for two reasons:
1. the deposits of gold with the government would be
discourage.
2. People would change their paper money for gold.

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FISHER’S MONETARY THEORY

In an article published in 1925, he concluded that "changes in

price level almost completely explain fluctuations in trade, for
the period 1915-23."
After the crash of 1929:
- fisher saw in the growth of debts the greatest cause of deflation
and depression.
* 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.
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FISHER’S MONETARY THEORY

Fisher's solution was to require 100% reserves behind demand

deposits, thereby divorcing the process of creating and destroying
money from the business of banking:
* a government currency commission would offer to buy liquid bank
assets(up to 100% of the bank's checking deposits) for currency or
lend to banks currency on those assets as security. Then all check
books money would have actual currency behind it. Thereafter all
demand deposits would have to be cracked 100% by currency
reserves.
This now familiar mechanism of open-market operations of the
federal reserve system would be a substitute for gold price 14
variation that fishers has advocated earlier. The country had
MILTON FRIEDMAN
 Born 1912
 is the leading monetarist of recent
decades.
 he has spent most of his professional life
as a professor of economics at the
university of Chicago, where he is the
major figure of the "Chicago school" of
laissez-faire economics and public
policies. MILTON FRIEDMAN
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MILTON FRIEDMAN
 Friedman believes "that inflation is always and everywhere a
monetary phenomenon, produced in the first instance by an
un duly rapid growth in the quantity of money."
 The only effective way, he asserted, to stop inflation is to
restrain the rate of growth of the quantity of money.
 The money supply should be allowed to increase by 3% to 5%
each year, with the expansion kept at a uniform rate when
considered monthly or even weekly.

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MILTON FRIEDMAN
 Friedman also advocates a system of 100% reserve banking.
For every dollar of deposits, banks would be required to hold a
dollar of currency or it's equivalent.
 The banks could lend out only the capital of their owners, or
the capital they would raise by selling stocks or bonds to the
public; they would thereby lose the power to create or destroy
money. the essence of this plan, Friedman said, is to make all
money whether currency or deposits, a direct liability of the
government.

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MILTON FRIEDMAN
 The Federal Reserves banks could increase reserves in a
series of steps by buying the government bonds in the open
market.
 Commercial banks' reserves with Federal Reserves Bank plus
cash in their vaults plus government securities they own add
up to about half their demand and time deposits.
 The Federal Reserve Bank could pay this interest from their
earnings on the government securities they hold.

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MILTON FRIEDMAN
 Friedman attributed the decline in business activity to the
shrinkage in the supply of money. A decline in consumption
and investment spending and in income could cause shrinkage
of currency in circulation and demand deposits.
 There is no doubt that monetary policy can be powerful tool in
stabilization policy, but to neglect all other factors that can
cause or affect fluctuations is a serious weakness of his
analysis. It fits well with his predilection for laissez-faire.
 Underlying Friedman's analysis is his political view that the
government should stay out of economic affairs as much as 19
possible. His economic analysis thus runs parallel with his
political preference, that is laissez-faire government.
DEMAND FOR MONEY
The demand for money is the desired holding of financial assets in the
form of money: that is, cash or bank deposits.

1. THE TRANSACTION DEMAND FOR MONEY

-The total amount of money balances that everyone wishes to hold for all
purchases is called Demand for Money.
The transaction motive for holding money is the reason for wanting
originally stressed in the quantity theory.

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DEMAND FOR MONEY
Money is passed 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 firms.
These transaction force both firms and households to hold money
balances called Transaction balances.
Transaction Balances must be held because payment and receipts are
not perfectly synchronized. The more often that wages are paid, the
more nearly synchronized payments and receipts will be and the smaller
will the balance held need to be.

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DEMAND FOR MONEY
2. THE PRECAUTIONARY MOTIVE
-To be able to continue in business without a recurring series of
cash crises during times in which receipts are abnormally high,
firms carry money balances for precautionary motives. these are
called Precautionary balances.
-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 disbursement.
The protection provided by a given quantity of precautionary
balances depends on the volume of payments and receipts.

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DEMAND FOR MONEY
The firm's precautionary demand for money is
expected to rise as the value of its sales rises.
Aggregating all firms and house-holds, the total
precautionary demand for money will rise as
national of holding such funds.
Firms can also be expected hold more funds for
precautionary purposes the lower the opportunity
cost of holding such funds,
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DEMAND FOR MONEY
3. THE SPECULATIVE MOTIVE
- Balances held in anticipation of a fall in the price
of assets are called speculative balances.
This applies to anything that is bought and sold,
including stocks and bond.

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DEMAND FOR MONEY
4. THE INFLUENCE OF INTEREST RATES ON
THE DEMAND FOR MONEY
The market rate of interest reflects the
opportunity cost of money holdings(the money
could be lend to and earn the market rate).

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DEMAND FOR MONEY
The rate of interest also influences decision
whether to hold money for speculative
purposes.This occur because of the inverse
relationship between prices of bonds and interest
rates.
Liquidity preference refers to tthe demand to hold
assets in the form of money rather than as in
interest-earning wealth.
The schedule relating the demand for money to 26

the interest rate is called the liquidity preference

 THANK
YOU!
GROUP 5
LOCATION
LA CONSOLACION UNIVERSITY PHILIPPINES

SUBJECT
MONETARY POLICY AND CENTRAL BANKING