Chapter Two

[Money] is a machine for

FISCAL AND MONETARY POLICY
doing quickly and
commodiously what would
be done, though less
quickly and commodiously,
without it.

JOHN STUART MILL

 What is MONEY?

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 • For Juan dela Cruz,
money is the thing
that puts food on
the table and a coat
on your back.

• For Bill Gates, the

wealthiest man in
the world, money
can mean his cash,
assets or wealth.

Copyright © Houghton Mifflin Company. All rights reserved. 1|3

 Money
• Anything that people regularly use
to buy goods and services from
other people

• It can be anything accepted as a

means of paying for goods or
services or for paying off debts

Copyright © Houghton Mifflin Company. All rights reserved. 1|4

 In the history of the world, what
item was used for money over
the broadest geographic area
and for the longest period of
time?

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Cowries served as money as early as 700 B.C. in China. By the 1500s, they were in
widespread use across India and Africa. For several centuries after that, cowries
were used in markets including southern Europe, western Africa, India, and China
for a wide range of purchases: everything from buying lunch or a ferry ride to
paying for a shipload of silk or rice. Cowries were still acceptable as a way of
paying taxes in certain African nations in the early twentieth century.

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 MONEY
MONEY

●●Standard
Standard medium
medium of of exchange
exchange inin business
business
transactions
transactions
●●Refers
Refers to
to the
the currency
currency and
and coins
coins which
which are
are
in
in circulation
circulation and
and legal
legal tender
tender

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 Stages
Stages in
in the
the Evolution
Evolution of
of Money
Money

1-Barter
2-Commodity Currency
3-Metallic Money
4-Paper currency
5-Checks
6-Electronic Payment
7-E-Money
Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
 Nature
Nature of
of Money
Money
●●Barter
Barter versus
versus Monetary
Monetary Exchange
Exchange
♦♦AA barter
barter system
system (with
(with nono money)
money) would
would be
be
awkward
awkward and
and extremely
extremely inefficient.
inefficient.
♦♦Money
Money greases
greases the
the wheels
wheels ofof exchange
exchange thus,
thus,
makes
makes the
the whole
whole economy
economy more
more productive.
productive.
♦♦Money
Money comes
comes inin the
the form
form of
of tokens
tokens (coins
(coins and
and
paper
paper money)
money) that
that have
have value
value established
established by
by aa
commonly
commonly recognized
recognized authority.
authority.
Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
 Nature
Nature of
of Money
Money
●●The
The Conceptual
Conceptual Definition
Definition of
of Money
Money
♦♦The
The functions
functions of
of money:
money:
■■Medium
Medium of of exchange
exchange
■■Unit
Unit of
of account
account
■■Store
Store of
of value
value
■■Means
Means ofof deferred
deferred payment
payment

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 Characteristics
Characteristics of
of Money
Money
♦♦ General
General acceptability
acceptability (legal
(legal tender)
tender)
♦♦ Stability
Stability of
of value
value (purchasing
(purchasing power)
power)
♦♦ Portability
Portability
♦♦ Cognizability
Cognizability
♦♦ Durability
Durability
■■ Note:
Note: Peso
Peso bill
bill has
has aa circulating
circulating life
life of
of 33 months
months
♦♦ Divisibility
Divisibility
♦♦ Malleability
Malleability
♦♦ Convertibility
Convertibility
Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
 R.A.
R.A. No.
No. 7653
7653 (New
(New Central
Central Bank
Bank Act
Act of
of 1993)
1993)

Legal
Legal tender
tender in
in the
the Philippines:
Philippines:
1.P50
1.P50 for
for denominations
denominations of of 25-sentimo
25-sentimo and
and
above
above coins
coins (1-Piso,
(1-Piso, 5-Piso
5-Piso and
and 10-Piso)
10-Piso)
2.P20
2.P20 for
for denominations
denominations of of 10-sentimo
10-sentimo or
or less
less
coins
coins (1-sentimo,
(1-sentimo, 5-sentimo)
5-sentimo)
3.All
3.All bills
bills (or
(or notes)
notes) up
up to
to any
any amount
amount

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 BSP
BSP Circular
Circular No.
No. 537,
537, Series
Series of
of 2006
2006

Legal
Legal tender
tender inin the
the Philippines:
Philippines:
1.P1,000
1.P1,000 for
for denominations
denominations of of 1-Piso,
1-Piso, 5-Piso
5-Piso
and
and 10-Piso
10-Piso coins
coins
2.P100
2.P100 for
for denominations
denominations of of 1-sentimo,
1-sentimo, 5-
5-
sentimo,
sentimo, 10-sentimo,
10-sentimo, and and 25-sentimo
25-sentimo coins
coins
3.All
3.All bills
bills (or
(or notes)
notes) upup to
to any
any amount
amount

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 Nature
Nature of
of Money
Money
●●What
What Serves
Serves as
as Money?
Money?
♦♦Commodity
Commodity money
money (metallic
(metallic form)
form)
♦♦Credit
Credit money
money (promissory
(promissory note)
note)
♦♦Paper
Paper money
money
♦♦Fiat
Fiat money
money (value
(value fixed
fixed by
by government
government edict
edict
or
or decree)
decree)

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 How
How Money
Money Supply
Supply is
is
Measured
Measured
There
There isis no
no single,
single, obvious
obvious place
place to
to draw
draw the
the line
line
between
between “money”
“money” andand “near
“near money.”
money.”
●●M1
M1 (standard
(standard monies)
monies) == coins
coins and
and paper
paper money
money inin
circulation
circulation and
and demand
demand deposits
deposits
-includes
-includesthose
thosemonies
moniesthat
thatare
arevery
veryliquid
liquidsuch
suchas
ascash,
cash,
checkable
checkable(demand)
(demand)deposits,
deposits,and
andtraveler’s
traveler’schecks
checks
●●M2
M2 (money
(money equivalents)
equivalents) == M1
M1 ++ money
money market
market
instruments
instruments
-less
-lessliquid
liquidininnature
natureand
andincludes
includesM1
M1plus
plussavings
savingsand
andtime
time
deposits,
deposits,certificates
certificatesof
ofdeposits,
deposits,and
andmoney
moneymarket
marketfunds
funds
Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
 How
How Money
Money Supply
Supply is
is
Measured
Measured
●● M3
M3 (net
(netperformance
performanceapproach)
approach)== PSC
PSC++ GSC
GSC++FSC
FSC
Private
Private sector
sector contribution
contribution (PSC)
(PSC)
♦♦ Total
Total loans
loans granted
granted –– total
total private
private sector
sector deposits
deposits
Public
Public sector
sector or
or the
the government
government contribution
contribution (GSC)
(GSC)
♦♦ Total
Total government
government expenditures
expenditures –– total
total government
government
deposits
deposits
Foreign
Foreign sector
sector contribution
contribution (FSC)
(FSC)
♦♦ Total
Total foreign
foreign loans
loans –– total
total foreign
foreign deposits
deposits

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 How
How Money
Money Supply
Supply is
is
Measured
Measured
A.
A.Consider
Considerthe
thefollowing
followingcurrencies
currenciesin
inan
aneconomy:
economy:

Coins
Coins PP200,000
200,000
Total
Totalprivate
privatedeposit
deposit PP600,000
600,000
Paper
Papermoney
money PP800,000
800,000
Total
Totalgovernment
governmentexpenditures
expenditures PP600,000
600,000
Demand
Demanddeposit
deposit PP400,000
400,000
Total
Totalgovernment
governmentdeposits
deposits PP500,000
500,000
Money
Moneymarket
market PP200,000
200,000
Total
Totalforeign
foreignloans
loans PP900,000
900,000
Total
Totalprivate
privateloans
loans PP800,000
800,000
Total
Totalforeign
foreigndeposits
deposits PP300,000
300,000

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 How
How Money
Money Supply
Supply is
is
Measured
Measured
QUESTIONS:
QUESTIONS:

●● How
How much
much is
is the
the supply
supply of
of money
money using
using the
the
standard
standard monies
monies approach
approach (M1)?
(M1)?
●● How
How much
much isis the
the supply
supply of
of money
money using
using the
the money
money
equivalent
equivalent approach
approach (M2)?
(M2)?
●● How
How much
much is
is the
the supply
supply of
of money
money using
using the
the net
net
performance
performance approach
approach (M3)?
(M3)?

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 How
How Money
Money Supply
Supply is
is
Measured
Measured
B.
B. Given
Given the
the following
following information:
information:

Reserve
Reservedeposit
deposit PP500,000
500,000
Reserve
Reserveratio
ratio 55percent
percent

●● Using
Usingthe
thefractional
fractionalreserve
reservebanking
bankingsystem,
system,how
howmuch
muchcan
can
be
beloaned
loanedout
outto
toborrowers?
borrowers?
●● How
Howmuchmuchisisthe
the change
changein inthe
thetotal
totalmoney
moneysupply
supplyififthe
the
initial
initialchange
changeinindeposit
depositisisPP500,000?
500,000?

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 Limits
Limits to
to Money
Money Supply
Supply

●● R.A
R.A ## 7653
7653 Section
Section 53
53
♦♦ Whenever
Whenevermoney
moneyaggregates
aggregatesor orlevel
levelof
ofcredit
credit
increases
increasesby
bymore
morethan
than15%
15% ororthe
thecost
costofofliving
living
index
indexincreases
increasesby
bymore
morethan
than10%
10%in inrelation
relationtotothe
the
level
levelof
ofexisting
existingat
atthe
theend
endofofpreceding
precedingperiod
periodor or
when
whenthe
thecircumstances
circumstancesso so warrant…,
warrant…,thetheMonetary
Monetary
Board
Boardshall
shallmake
makechanges
changesininmoney
moneylimits
limitsto
toprovide
provide
aamore
morestable
stablepeso
pesoand
andPhilippine
Philippineeconomy
economy

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 Fiscal
Fiscal and
and Monetary
Monetary Policy
Policy

●●R.A
R.A 7653
7653 :: aa constitutional
constitutional provision
provision
creating
creating the
the Bangko
Bangko Sentral
Sentral ng
ng Pilipinas
Pilipinas
●●BSP
BSP isis mandated
mandated to:
to:
■■ maintain
maintaindomestic
domestic stability
stabilityof
ofPhilippine
Philippinepeso
pesoand
andits
its
convertibility
convertibilityinto
intoforeign
foreigncurrencies
currencies
■■ manage
managemoney
moneysupply
supplyorormoney
moneyaggregate
aggregateatataacertain
certain
level
level
■■ monitor
monitortendencies
tendenciesof ofinflation
inflationand
anddeflation
deflation
■■ implement
implementfiscal
fiscaland
andmonetary
monetarypolicies
policies

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 The
The Banking
Banking System
System
●●How
How Banking
Banking Began
Began
♦♦Fractional
Fractional reserve
reserve banking
banking began
began when
when
goldsmiths
goldsmiths realized
realized they
they could
could profitably
profitably lend
lend
out
out aa portion
portion of
of the
the gold
gold that
that had
had been
been
deposited
deposited with
with them
them for
for safekeeping.
safekeeping.
♦♦The
The “Goldsmith
“Goldsmith Tale”
Tale”
Short video
presentation

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

The
The Fractional
Fractional Banking
Banking System
System

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 The
The Banking
Banking System
System
●●How
How Banking
Banking Began
Began
♦♦Three
Three important
important features
features of
of the
the fractional
fractional
reserve
reserve banking
banking system:
system:
■■Bank
Bankprofitability
profitability
■■Banks
Banksdiscretion
discretionover
overthe
themoney
moneysupply
supply
■■Exposure
Exposuretotobank
bankruns
runs

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 The
The Banking
Banking System
System
●●Principles
Principles of
of Bank
Bank Management:
Management:
Profits
Profits versus
versus Safety
Safety
♦♦To
To make
make aa profit,
profit, aa banker
banker must
must take
take risks.
risks.
♦♦But
But because
because the
the business
business isis risky,
risky, the
the same
same
banker
banker must
must also
also emphasize
emphasize safety.
safety.
♦♦The
The heart
heart of
of banking
banking isis to
to be
be torn
torn between
between thethe
two
two principles.
principles.

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 The
The Banking
Banking System
System
●●Bank
Bank Regulation
Regulation
♦♦Deposit
Deposit insurance
insurance
■■Eliminates
Eliminatesthe
themotive
motivefor
forcustomers
customersto
towithdraw
withdrawfunds
funds
because
becauseofofbad
badnews
newsregarding
regardingthe
thebank’s
bank’sfinances
finances
♦♦Moral
Moral hazard
hazard
■■When
Whenan anindividual
individualisisinsured
insuredagainst
againstrisk,
risk,he/she
he/sheputs
puts
forth
forthlittle
littleeffort
effortto
toavoid
avoidrisk
risk
■■Deposit
Depositinsurance
insurancecould
couldmake
makethethebanking
bankingsystem
systemless
less
safe
safe

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 The
The Banking
Banking System
System
●●Bank
Bank Regulation
Regulation
♦♦Bank
Bank Supervision
Supervision
■■Needed
Neededto toreduce
reducemoral
moralhazard
hazardproblem
problem
■■Ensures
Ensuresbanks
bankstake
takeonly
onlysensible,
sensible,defensible
defensiblerisks
risks
■■Controls
Controlsthe
themoney
moneysupply
supply
♦♦Reserve
Reserve Requirements
Requirements
■■Helps
Helpscontrol
controlthe
themoney
moneysupply
supply

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 The
The Origins
Origins of
of the
the Money
Money
Supply
Supply
●●How
How Bankers
Bankers Keep
Keep Books
Books
♦♦Banks
Banks keep
keep balance
balance sheets
sheets
■■Assets
Assets == liabilities
liabilities++net
networth
worth
♦♦Assets
Assets include:
include:
■■Reserves
Reserves
■■Loans
Loans
♦♦Liabilities
Liabilities include:
include:
■■Deposits
Depositsowed
owedto
tocustomers.
customers.
Copyright© 2006 South-Western/Thomson Learning. All rights reserved.
TABLE
TABLE 1:
1: Balance
Balance Sheet
Sheet of
of Bank-a-mythica
Bank-a-mythica
Dec.
Dec. 31,
31, 2004
2004

Copyright
Copyright©© 2006 South-Western/Thomson Learning. All rights reserved.
 Banks
Banks and
and Money
Money Creation
Creation
●●The
The Limits
Limits to
to Money
Money Creation
Creation by
by aa Single
Single
Bank
Bank
♦♦Banks
Banks can
can lend
lend money
money inin their
their vault
vault that
that isis
above
above the
the minimum
minimum required
required reserve
reserve ratio.
ratio.
♦♦In
In doing
doing so,
so, they
they create
create new
new money.
money.

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

TABLE
TABLE 2:
2: Balance
Balance Sheet
Sheet ofof Bank-a-mythica’s
Bank-a-mythica’s
Jan.
Jan. 2,
2, 2005
2005

Copyright
Copyright©© 2006 South-Western/Thomson Learning. All rights reserved.
 Banks
Banks and
and Money
Money Creation
Creation
●●Multiple
Multiple Money
Money Creation
Creation by
by aa Series
Series of
of
Banks
Banks
♦♦When
When all
all banks
banks make
make loans
loans with
with funds
funds they
they
have
have that
that are
are above
above the
the required
required reserve
reserve ratio,
ratio,
the
the society’s
society’s money
money supply
supply expands.
expands.

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 The
The Need
Need for
for Monetary
Monetary
Policy
Policy
●● Left
Left uncontrolled,
uncontrolled, banks
banks would:
would:
♦♦Reduce
Reduce the
the money
money supply
supply in
in aa recession
recession
♦♦Increase
Increase the
the money
money supply
supply during
during boomboom
periods
periods
●● Changes
Changes inin the
the money
money supply
supply would
would exacerbate
exacerbate
the
the business
business cycle.
cycle.
●● One
One reason
reason for
for monetary
monetary policy,
policy, therefore,
therefore, isis to
to
prevent
prevent this
this behavior
behavior on
on the
the part
part of of banks.
banks.

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

 Money  Store of value
 Barter  BSP
 Economy  Payment
 Medium of exchange  Cognizability
 Inflation  R.A. 7653
 Fiat money  Money supply
 Commodity money  Portability
 Monetary board  Credit money
 Paper money  Philippine peso
 Money market  Deflation
instruments  Monetary policy
 Durability  Money aggregates
 Legal tender  Cost of living index