Republic of the Philippines
CATANDUANES STATE UNIVERSITY
COLLEGE OF BUSINESS AND ACCOUNTANCY
Virac, Catanduanes
LEARNING MATERIAL
In
MONETARY POLICY &
CENTRAL BANKING
A compilation of lessons/ activities
Final Term (Module 2)
MELINDA V. ABICHUELA, MBA
July, 2022
Monetary Policy and Central Banking
Disclaimer
This learning material is used in compliance with the flexible teaching-learning
approach espoused by CHED in response to the pandemic that has globally affected
educational institutions.
Authors and publishers of the contents are well
acknowledged as such the college and its faculty do not claim ownership of all
sourced information.
This learning material will solely be used for instructional
purposes not for commercialization.
CatSU College of Business and Accountancy
Module 2
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Monetary Policy and Central Banking
OVERVIEW
This learning material is prepared as a reference for students taking up
Bachelor of Science in Business Administration, major in Financial
Management course at the College of Business and Accountancy this 1ST
Semester, SY 2022-2023.
The coverage of this learning material is as follows:
Chapter 4 : Money Creation and Framework.
Chapter 5 : Monetary Policy: Models and Transmission.
Chapter 6 : The Central Bank Act of the Philippines (RA 7653).
The Author
Module 2
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Monetary Policy and Central Banking
Table of Contents
Page
Disclaimer
i
Module Overview
ii
Learning Outcomes
iv
Module Map
v
Introduction
vi
Money Creation & Framework
Chapter4
1
Monetary Policy:Models & Transmission
Chapter 5
4
References
7
The Central Bank Act of the Philippines(RA 7653)
Chapter 6
8
References
9
Learning Assessment
10
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Monetary Policy and Central Banking
Central Banks play a vital role in ensuring economic and financial stability. They conduct
monetary policy to achieve low and stable inflation. In the wake of the global financial crisis, Central
banks have expanded their toolkits to deal with risks to financial stability and to manage volatile
exchange rates. Central Banks need clear policy frameworks to achieve their objectives.
This module will show you how the global financial crisis, central banks, eased monetary
policy by reducing interest rates until short-term rates came close to zero, which limited the option to
cut policy rates further (i.e., limited conventional monetary options). With the danger of deflation rising,
central banks undertook unconventional monetary policies, including buying long-term bonds with the
aim of further lowering long term rates and loosening monetary conditions. A module map is accessible
to help you generate a rational map of the foremost concepts in the module. Learning inputs and
activities were gently chosen and established to ease your mastery of the content. At the end of this
module is an assessment of learning to, determine if the intended learning outcomes have been ideally
achieved.
This module includes the topics as contained in the course syllabus for Monetary Policy and
Central Banking. Discussion, examples and illustrations for every lesson or topic were direct-to-thepoint to facilitate easy learning and mastery of the course.
Module Part 2 (Final Term coverage) has 3 topics:
4. Money Creation & Framework
5. Monetary Policy: Models & Transmission
6. The Central Bank Act of the Philippines
Learning Outcomes
After remarkably completing this module, the student shall be able to:
1. Exemplify Money Creation and Framework: measuring money; explain the context of money
creation; monetary policy framework; limitation of monetary policy; instruments of monetary
policy.
2. Expound Monetary Policy Models and Transmission: Elucidate models of monetary policy;
Illustrate the Path of monetary policy from interests to inflation.
3. Describe the Central Bank Act of the Philippines (RA 7653).
4. Convey gratitude for humanity and for monetary and central banking, towards financial stability
of a country.
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Module Map
Presented below is a Module Map of Part 2 containing the topics covered
in the duration of the Final Examination.
Chapter
4
5
6
Topics
Money Creation & Framework
Monetary Policy: Models & Transmission
The Central Bank Act of the Philippines
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Monetary Policy and Central Banking
Introduction
A key role of central banks is to conduct monetary policy to achieve price stability (low and
stable inflation) and to help manage economic fluctuations. A central bank is an independent national
authority that conducts monetary policy, regulates banks, and provides financial services including
economic research. Its goals are to stabilize the nation's currency, keep unemployment low, and
prevent inflation.
Most central banks are governed by a board consisting of its member banks. The country's
chief elected official appoints the director. The national legislative body approves him or her. That
keeps the central bank aligned with the nation's long-term policy goals. At the same time, it's free of
political influence in its day-to-day operations. Central banks affect economic growth by controlling
the liquidity in the financial system. They have three monetary policy tools to achieve this goal.
First, they set a reserve requirement. It's the amount of cash that member banks must have on hand
each night. The central bank uses it to control how much banks can lend.
Second, they use open market operations to buy and sell securities from member banks. It changes
the amount of cash on hand without changing the reserve requirement. They used this tool during the
2008 financial crisis. Banks bought government bonds and mortgage-backed securities to stabilize the
banking system.
Third, they set targets on interest rates they charge their member banks. That guides rates for loans,
mortgages, and bonds. Raising interest rates slows growth, preventing inflation. That's known
as contractionary monetary policy. Lowering rates stimulates growth, preventing or shortening
a recession. That's called expansionary monetary policy.
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Chapter 4. MONEY CREATION
& FRAMEWORK
4.1 Measuring Money
In Economics: Money supply or money stock is the total amount of monetary asset
available in the economy at a specific time.
The characters in the money supply
1. Central Bank the government agency that oversees the banking system and is responsible
for the conduct of monetary policy.
2. Banks the financial intermediaries that accept deposits from individual and institutions and
make loans: commercial banks, savings and loan associations, mutual savings bank and
credit unions.
3. Depositors Individuals and institutions that hold deposits in banks.
4. Borrowers Individuals and institutions that borrow from the depository institutions and
institutions that issue bonds that are purchased by the depository institutions.
Money Supply Determinants
1. M1 Currency (Coins + paper money) + demand deposits at commercial bank.
2. M2 M1+ savings and time deposits at commercial banks.
3. M3 M2 + savings and time deposits at mutual savings banks, savings and loans association,
and credit unions.
What is CURRENCY?
• It is consists of coins and paper money held by non-bank public. It excludes substantial
amounts held by the treasury, reserve system and commercial banks.
• Currency outside banks is determined by the public household, business firms, and state and
local governments. It is not determined by national government, treasury, and reserve system.
What is DEMAND DEPOSITS?
Non-Principal Participants
in the Financial System:
• Financial exchanges and broker-dealers
• Fund managers
• Regulators
• Rating agencies
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What is SAVINGS DEPOSIT?
are represents typically by the familiar passbook deposits, but more recently also by so-called
statement savings deposit. Deposits and withdrawals maybe made in person, in any amount, at any
time, and are recorded in the passbook.
Non-Negotiable Certificate of Deposits
These are time deposits issued in the form of certificates of designated denominations, saving fixed
maturity dates, subject to a 30 day minimum maturity and bearing fixed rates of interest to maturity.
Negotiable certificates of deposits
Popularly known as CDs.
These certificates of deposits are issued mostly by large commercial banks with average maturity of
CDs of 90 days and having fixed maturity dates and interest rates.
Open-Account Time Deposits
Similar to non-negotiable certificates possessing fixed maturity dates subject to a 30 day minimum
maturity and/or deposits.
Time and Savings Deposits
at Saving Institution
Deposits at mutual savings and loan associations and credit unions are fundamentally similar to the
time and savings deposits at commercial banks except that the saving institutions – apart from few,
very large, savings and loan associations do not issue negotiable CDs
MONETARY THEORIES
Considering a long stabilized foundation of principles in managing money, theories of different
explanation where used. It explains the movements and cause and effect relationship of factors that
result change of different phenomena in money.
The Quantity Theory
Monetarism
Cambridge Cash-Balance Approach
Liquidity Preference
THE QUANTITY THEORY
• This theory states that because velocity is constant, a change in money supply causes a
proportionate change in nominal gross national product.
• It assumes as the economy is at full employment, then real GNP is constant.
• If both velocity and real GNP are constant then a change in the money supply causes a
proportionate change in the price level.
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MONETARISM
• Another theory that explains monetary disturbances are the major cause of economic
fluctuations. Monetarist restates the quantity theory of money give three important shifts.
• First, they believe that “only money matters”
• Second, outside of deep depressions monetary policy does affect the economy.
Third, velocity is not constant but depends on interest rates and other factors.
CAMBRIDGE CASH-BALANCE APPROACH
According to Alfred Marshall, money is used as a store of wealth between the sale of some items and
purchase of others. Since purchases and sales depend on a nation’s GNP, they assumed that demand
for money is proportional to nominal GNP.
LIQUIDITY PREFERENCE
This argument contradicted the classical assumption that velocity is fixed. If the demand for money
depends on interest rates, then velocity depends on interest rates. In particular, an increase in interest
rates reduces the demand for money and increases velocity.
MONEY MULTIPLIER
•
In monetary economics, money multiplier is one of various closely related ratios of commercial
bank money to central bank money under fractional reserve banking system.
M= R x (1/RR)
where M=commercial banks money loans
R = Reserves(Central Bank Money)
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Chapter V Monetary Policy
& Models
MODELS OF MONETARY POLICY
What is MONETARY POLICY?
Measures or actions taken by the Central Bank to influence the general price level and the level of
liquidity in the economy. Monetary Policy action of the Central Bank are aimed at influencing the timing
cost and availability of money and credit, as well as other financial factors, for the main objective of
stabilizing the price level.
Model #1:
FIRM REQUIRED RESERVES MODEL
• Notes and coins do not rank as reserves
• The required reserve (RR) comes into play that deposits increase as a result of new bank
loans extended or the purchase of newly issued securities.
• The banks can get additional required reserves only by borrowing from the Central Bank.
• That only means bank cannot supply any further loans unless the Central Bank supply
borrowed reserve.
Example
-If the banking system is in balance (meaning no BR and ER) and the money stock is in the form of
PhP 100,000,000,000.00 and the Central Bank would like the money stock in this form to grow by 12%
over 12 months, it will supply additional reserves to the extent of 2.4 Billion which will be used by the
banking sector as the “backing” for money stock growth of 12 Billion.
-The money stock has increased by 12,000,000.00 and Excess Reserve has shifted to Required
Reserve. It will be quite evident by now that once the banking system has expanded to the point where
all its ER shifted into RR, it cannot expand any further. The lending rate of the banks will increase
sharply.
Model # 2:
FIRM BORROWED RESERVES MODEL
-The Central Bank relies entirely on interest rates to allocate funds, and has absolute control over
interest rates.
-The existence of loans to banks, the outstanding amount which is also called the liquidity shortage, is
what makes the Key Interest Rate effective and influences the bank’s interest rates on both sides of
their balance sheets (lending rate, demand for loans, economic variable, exchange rates).
-In this model the banks are permanently indebted to the Central Bank and it has been able to “control”
the bank’s lending rates in almost exacting fashion.
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Model # 3:
INTERBANK RATE MODEL
•
It is a model where a number of central banks position themselves in terms of monetary
policy.
•
Example Monetary policy of Canada
The bank carries out monetary policy by influencing short-term interest rates. It does this by raising
and lowering the “target for the overnight rate.”
“The overnight rate is the interest rate at which major financial institutions borrow and lend one-day
(or “overnight”) funds among themselves; the Ban sets a target level for that rate. This target for
overnight rate is often referred to as “Bank’s Key Interest Rate or Key Policy Rate”.
Changes in the target for the overnight rate influence other interest rtes, such as those for consumer
loans and mortgages. They can also affect the exchange rate.
The instrument that the Bank uses to ensure that inflation remains within this target range is the BANK
RATE – the rate of interest that the Bank charges on short-term loans to financial institutions.
THE PHILIPPINE
MONETARY POLICY
Primary Objective of BSP:
To promote price stability conducive to a balanced and sustainable growth of the economy (RA 7653).
The adoption of INFLATION TARGETING FRAMEWORK of monetary policy in January 2002 is aimed
at achieving this objective.
INFLATION TARGET:
The government’s inflation target is defined in terms of the average year-on-year change in the
Consumer Price Index over the calendar year.
• Example
The inflation target have been set at 3.5% with a tolerance interval of +-1% point (2009). In
2010, 4.5% with a tolerance interval of + 1 % point.
What is CONSUMER PRICE INDEX?
-Represents the average price for a given period of a standard basket of goods and service consumed
by a typical Filipino family.
-This standard basket contains of hundreds of consumption items such as food products, clothing,
water, and electricity whose price movements are monitored to determine the overall change in the
CPI or the level of inflation.
-The BSP has a number of monetary policy instruments at its disposal to promote price stability. To
increase or reduce liquidity in the financial system, the BSP uses OPEN MARKET OPERATION,
accepts fixed-term deposits, offers standing facilities, and requires banking institutions to hold reserves
on deposits and deposit substitutes.
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What is CONSUMER PRICE INDEX?
-Represents the average price for a given period of a standard basket of goods and service consumed
by a typical Filipino family.
--This standard basket contains of hundreds of consumption items such as food products, clothing,
water, and electricity whose price movements are monitored to determine the overall change in the
CPI or the level of inflation.
-The BSP has a number of monetary policy instruments at its disposal to promote price stability. To
increase or reduce liquidity in the financial system, the BSP uses OPEN MARKET OPERATION,
accepts fixed-term deposits, offers standing facilities, and requires banking institutions to hold reserves
on deposits and deposit substitutes.
OPEN MARKET OPERATION
• A key component of monetary policy implementation.
Consists of the following:
-Repurchase and reverse repurchase
-Foreign exchange swap
Repurchase and
Reverse Repurchase Transactions
-In a repurchase or repo transaction, the BSP buys government securities from a bank with a
commitment to sell it back at a specified future date at a pre-determined rate. The BSP’s payment to
the bank increases the latter’s reserve balances has an expansionary effect on liquidity.
Repurchase and
Reverse Repurchase Transactions
-In a reverse repo, the BSP acts as a seller of government securities and the bank’s payment has a
contractionary effect on liquidity.
RP and RRP transactions have maturities ranging from overnight as well as two weeks to one month.
FOREIGN EXCHANGE SWAPS
Refers to transactions involving the actual exchange of two currencies (principal amount only) a
specific date at a rate agreed on the deal date (the first leg), and a reverse exchange of the same
two currencies at a date further in the future (the second leg) at a rate (different from the rate applied
to the first leg) agreed on deal date.
ACCEPTANCE OF FIXED
TERM DEPOSITS
The Bangko Central ng Pilipinas accepts deposits from the banks. The Special Deposit Accounts
(SDA) facility consists of fixed-term deposits by banks and by trust entities of banks and non-bank
financial institutions with the BSP. It was introduced in November, 1998 to enable the BSP to expand
its toolkit in liquidity management.
STANDING FACILITIES
• The BSP extends discounts, loans and advances to banking institutions in order to influence
the volume of credit in the financial system.
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-Rediscounting is the standing credit facility provided by the BSP to help banks meet temporary
liquidity needs by refinancing the loans they extend to their clientsRediscounting is the standing credit
facility provided by the BSP to help banks meet temporary liquidity needs by refinancing the loans they
extend to their clients
-The rediscounting facility allows a financial institution to borrow money from the BSP using promissory
notes and other loan papers of its borrowers as collateral.
There are two types of rediscounting facilities available to qualified banks: the PESO rediscounting
facility, and the Exporter’s Dollar and Yen Rediscount Facility which was introduced in 1995.
RESERVE REQUIREMENT
-Reserve requirements refer to the percentage of bank deposits and deposit substitute liabilities that
banks must keep on hand or in deposits with the BSP and therefore may not lend. Changes in reserve
requirement have a significant effect on money supply in the banking system, making them a powerful
means of liquidity management.
-Reserve requirement apply to pesos demand, savings, time deposit and deposit substitutes (including
long-term non-negotiable tax-exempt certificates of time deposit) of universal bank and commercial
banks and may be kept in the form of cash in vault, deposits with the BSP and government securities
REFERENCES
•
•
•
Fajardo, FR. & Manasala, MM. (2007). Business Finance. Manila: National Bookstore
Faure, AP. (2013). Central Banking and Monetary Policy: An Introduction, 1st Edition, Quoin
Institute Limited. ISBN 978-87-403-0605-7. Retrieved at bookboon.com
Laman, Laman, & Evia (2008) Financial System, Market, and Management.
Website of Bangko Central ng Pilipinas
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6 The Central Bank Act
Of the Philippines
(RA 7653)
ESTABLISHMENT AND ORGANIZATION OF THE
BANGKO SENTRAL NG PILIPINAS
ARTICLE II
THE MONETARY BOARD
•
•
SECTION 6. Composition of the Monetary Board.
The powers and functions of the Bangko Sentral shall be exercised by the
Bangko Sentral Monetary Board, hereafter referred to as the MonetaryBoard,
composed of seven (7) members appointed by the President of the Philippines
for a term of six (6) years.
THE GOVERNOR
-The Governor of the Bangko Sentral, who shall be the Chairman of the Monetary
Board. The Governor of the Bangko Sentral shall be head of a department and his
appointment shall be subject to confirmation by the Commission on Appointments.
-Whenever the Governor is unable to attend a meeting of the Board, he shall
designate a Deputy Governor to act as his alternate: Provided, That in such event,
the Monetary Board shall designate one of its members as acting Chairman;
Provided, That in such event, the Monetary Board shall designate one of its members
as acting Chairman;
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REFERENCES:
http://bsp.gov.ph
https://www.imf.org/en
https://www.sciencedirect.com
https://corporatefinanceinstitute.com/resources/knowledge
https://www.kobo.com/us
https://world101.cfr.org/global-era-issues/monetary-policy-and-currencies/
Faure, A.P. (2017). Central Banking and Monetary Policy: An Introduction,
Bookbon.com.
Fajardo, Feliciano R. and Manansala, Manuel M. (2017). Business Finance.
Manila,NBS
Hansen, A. (2018). Monetary Theory & Fiscal Policy. Papamoa Press.
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LEARNING ASSESSMENT
Test I. Multiple Choice. Choose the best answer and write the letter before each item number.
1. The government agency that oversees the banking system
a. Central Bank of the Philippines
b. Security and Exchange Commission
c. Monetary Board
d. None of the above
2. These are intermediaries that accept deposits from individuals or corporation and make
loans.
a. Banks
b. Financial Institutions
c. Micro-financial institutions
d. None of the above
3. It is the money supply determinants that composed of currency and demand deposits.
a. M1
b. M2
c. M3
d. None of the above
4. It is determined by public household, business firms, state and local governments.
a. Currency
b. Coins
c. Paper money
d. None of the above
5. These are time deposits issued in the form of certificates of designated denominations,
saving fixed maturity dates, subject to 30 day minimum maturity.
a. Non-negotiable certificate deposits
b. Negotiable certificate of deposits
c. Open-account time deposits
d. None of the above
6. It is an action taken by the Central Bank to influence the general price level of the level of
liquidity.
a. Reserve Model
b. Monetary Policy
c. Borrowed Reserve
7. This is a result of a new bank loans extended or the purchase of newly issued securities.
a. Borrowed reserve
b. Required reserve
c. Excess reserve
d. None of the above
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8. The Central Bank relies entirely on interest rates to allocate funds, and has absolute control
over interest rates.
a. Required reserve
b. Borrowed reserve
c. Excess Reserve
d. None of the above
9. It is a model where a number of Central Banks position themselves in terms of monetary
policy
a. Firm borrowed reserve model
b. Interbank rate model
c. Firm required reserve model
d. None of the above
10. It represents the average price for a given period of a standard basket of goods and service.
a. Gross National Product
b. Consumer Index
c. Gross Domestic Product
d. None of the above
11. The BSP buys government securities from a bank with a commitment to sell it back at a
specified future date at a pre-determined rate.
a. Open market operation
b. Reverse repurchase
c. Repurchase
d. None of the above
12. The BSP ct as a seller of government securities and the bank’s payment has a
contractionary effect on liquidity
a. Fixed term
b. Repurchase
c. Reverse repurchase
d. None of the above
13. It refers to the percentage of bank deposits and deposit substitute liabilities that banks
must keep on hand or in deposit with the BSP
a. Borrowed reserve
b. Excess reserve
c. Reserve requirement
d. None of the above
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14. It is consist of a fixed term deposit by banks and by trust entities of banks and non-bank
financial institutions with the BSP.
a. Standing facility
b. Open market operation
c. Acceptance of Fixed Term Deposits
d. None of the above
15. It promotes price stability conducive to a balanced and sustainable growth of the economy.
a. Central Banking
b. Interbank
c. Monetary Policy
d. None of the above
Test II. Modified TRUE or FALSE.
DIRECTION: Identify if the statement is TRUE or FALSE. If false underline the word or phrase
that makes it incorrect then write the correct word or phrase on the column before each
item number.
TRUE/FALSE/Wri
STATEMENT
te the correct
word
1. The quantity theory believes that “only money matters”.
2. The governor of the Bangko Sentral shall be the head of the
department.
3. Cambridge cash balance approach assumes that as the economy is at
full employment, the GNP is constant.
4. The powers and function of the BSP shall be exercised by the
Monetary Board
5. Borrowers are individuals and institutions that hold deposits in banks.
6. If the cabinet member unable to attend a meeting of the board, he
shall designate an undersecretary.
7. Central Bank is a financial intermediary that accepts deposits.
8. The members of the board must be a natural born citizen
9. Currency is determined by national government, treasury, and reserve
system.
10. The members of the monetary board coming from the private sector
shall not hold any other public office.
11. Open account deposits are subject to 90 day minimum maturity.
12. The President may remove any member of the monetary board.
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13. According to Manfred Marshall Money is used as a store of wealth.
14. Money supply or money stock is the total amount of monetary asset
available in the economy at a specific time.
15. In monetary economics, money multiplier is the only related ratios to
commercial bank money to central bank money.
16. Negotiable certificate of deposit is also known as CDs.
17. The appointment of the Governor of the BSP shall be subject to
confirmation by the Office of the President.
18. Open account time deposits are similar to non-negotiable certificates.
19. Five members from the private sector of the monetary board have a
minimum term of 3 years.
20. Demand deposits are checking accounts at commercial banks.
21. A member of the monetary board has a connection directly with any
multilateral banking.
22. Savings deposits are represented by familiar passbook deposits.
23. The salary of the members of monetary board shall be fixed by the
governor.
24. The quantity theory states that velocity is constant.
25. The governor shall maintain and preserve a complete record of the
proceedings and deliberations of the board
Test III. (10pts) evaluate if 100,000,000.00 that expected to grow at 12% annually could back up a
stock growth of 12 million. How? (Explain) You can support your explanation by presenting a
computation.
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