CHAPTE

R8
Money and Monetary Policy
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Have you heard the saying "Money makes the world go ground"? Indeed,
money has been a significant contribution to the world as it established a
system that facilitates the exchange of goods and services from the seller
to the buyer. Through its severalog 926rug of 21syud functions, it was
able to help the entire human race identify the value of a market's demand on a certain
product. It is like giving an identification to what you purchase and sell.
In the past, money has been in the form of gold and silver. Gold and
silver during those times are considered commodity money, or an
item that has an intrinsic value and used as a form of money. It has
intrinsic value when it has a value even if it is not to be used as money.
Another kind of money aside from commodity money is called fiat
money. Fiat money, meanwhile, cannot stand alone. Unlike gold,
the U.S. dollar bills will just be a worthless paper if there were
no government decree mandating its use. Thus, fiat
money's value only comes from the law that gives it value in the
area or country where it is used.

In Rome, salt was even used to compensate for pay

(that's where the word salary came from), and in Africa, it
was also used to bargain.
 Barter is the exchange of two different
commodities between two parties. Because there
was no money during that time, foreign sellers
would bring with them valuable items such as
Chinese silk or Arabian lamps. Filipinos,
meanwhile, bring kitchen wares and even
cattle to exchange for products that they may like
from foreign sellers. A Filipino exchanging a
carabao for a yard of silk back then is
possible. This is just one of the many
issues that were addressed
upon the existence of money.
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Learning Objectives
At the end of this chapter, the student should be able to:
1.

2.

3.

4.

discuss a brief history of money and

enumerate the different uses of money;
define the concepts related to banking;
discuss the different types and functions of
banks; and

identify the function of the Bangko

Sentral ng Pilipinas (BSP) relative to
monetary
policies.

Meaning and Use

It has been a common understanding that

the more money one has, the more that
 money

person can buy and use a certain product. By this understanding, we then consider as
wealth. Meanwhile, people in business, accounting, or finance
call it cash, an amount that businessmen and accountants enter
in their record books and balance. However, for economists,
money is more than that. It is much simpler. Money is an item
that is used by buyers to purchase goods and services. Hence, it
becomes the reason why sellers sell-to make money. After all, people engage in
business primarily because of earnings.
As a tool of the economy, money has three functions. It is a medium of
exchange, a unit of account, and a store of value. These three functions work hand in
hand to give money a different meaning from all the other tools that exist.
Medium of exchange. As a medium of exchange, money facilitates the transfer of a
product from one person to another. When you go to the grocery and buy your toiletries, you
do not pay using a piece of gold or a bag of fruit. You pay using money. The absence of
money will bring us back to the time of barter and exchange our bag of fruits or a piece of
gold for a few rolls of tissue paper, and maybe, a toothbrush and some tubes of
toothpaste.

Unit of account. Let us go back to you buying your toiletries in the grocery.
Suppose that you are no longer there to barter, you bring out your money
and count. You saw that the
roll of tissue that you bought costs Php
20.00, so you pull out your 20-peso bill and pay for the product.
Had you picked up two rolls of tissue paper, you would have
paid Php 40.00. Money as a unit of account becomes that
measure that people use to buy the goods that they want. If
centimeters are to length, and kilograms are to weight, then the
amount of money is to purchases.

Store of value. Have you ever kept a piggy

bank when you were younger? You store all your
 coins and some of your bills there and keep
them for future use. These bills and coins that
are accepted in your country are called currency. You
you desired when
use this to buy whatever
you were young. When you leave your
bills and coins in the piggy bank, say
Php 100, and bring those out after a
week, the value remains the same-100
pesos. It does not increase nor decrease. It
just stores the value and does not change.
Thus, money
114

MANAGERIAL ECONOMICS IN
THE 21ST CENTURY

stores the value that it carries.

Whatever number is imprinted in
that bill or minted on
that coin stays
there.
Importance
of Money
There are several realities that relate money
and monetary policy to the economy:
1.

2.

3.

4.

Stable value of money is

essential to trade.
Healthy banks are important for savers, investors, borrowers,
and the public. Markets play a vital role in the function of our
monetary system.
A well-designed and well-executed monetary policy is essential
for an economy to keep its resources fully employed.

For us to expound on these realities further, we need to

discuss what banks and banking are all about. Banks are
institutions that serve as intermediary between the savers
and the borrowers. They are the links of the people who
save and the people who
borrow.

Concept of
Banking
Banks are given the power by the government to conduct different functions
under its jurisdiction. The most basic of which are to accept deposits
from people who save, and to lend money to parties that need funding.
Depositors or savers place their money in banks for the purpose of: (1) earning
interest, (2) security from lost, and (3) storage.
When you place your money in the bank, it grows. The Php 1,000,000 invested
today, given a five percent (5%) annual interest, will grow to Php 1,500,000 in 10 years.
The interest is the percentage that banks pay the depositors. Meanwhile, different
individuals and companies need funding for their businesses and for emergencies.
They file for loans from banks for different purposes and return them after
an agreed period.
For example, ABC Company borrows Php 1,000,000 from XYZ
bank. It was charged by the bank with a 15% annual interest. After a
year, ABC Company would need to pay Php 1,150,000 to the bank for
the use of the money it borrowed. Hundreds and thousands of
transactions like this happen in banks. It is, therefore,
important for banks to ensure that the money of the
depositors is protected and the money lent to borrowers
is collected on time. These functions of deposit-taking
and credit/lending facilitated by banks are called the
Financial Intermediation Process.

CHAPTER 8 Money and Monetary Policy

115

Investment
Banking or
Underwriting
Brokerage
Trust
Operations
Deposit
Taking

International
Banking
Borrowings

Credit/
Lending
BANK

Provate
Banking
FCDU
Operations
Treasury
Operations
(Investment
Trading)
 Figure 8.1. Functions of Banks

Aside from deposit-taking and lending, other functions of banks include:

1.

2.

3.

116
Treasury Operations (investment/trading). Banks engage in the trading of the stocks of
companies. These activities shall be further discussed in the next chapter. Borrowing.
Banks also borrow from one another. If one day, a very wealthy depositor of a bank
wants to withdraw Php 20,000,000 from his/her account, the bank should then convert its
other assets to the medium of exchange and release the money of the depositor.
However, more often than not, banks would not do that. This requires a high level of
liquidity from the bank. Liquidity is the speed at which assets can easily be
converted to the accepted medium of exchange. Thus, the bank shall
coordinate with other banks and convert some of their assets to money and
release it to the depositor. If they can't, they risk a bank run. Bank run
happens when the public, learning of a possibility that the bank is no
longer capable of returning their money, “runs” to the bank to
 withdraw. When most depositors do this, it might just
be the end of the bank.

Trust Operations. From the word trust, trust operations allow the
managers of the depositors' money for a
banks to be the
specific purpose. An old grandmother may want her
two-year-old granddaughter to have a grand
celebration of her birthday in the future, and
instructs the bank to ensure that her money
will grow to a certain amount when her
granddaughter turns 18, making sure that she
birthday of her life.
will have the best
However, unlike regular bank
deposits, money placed in Trust are
MANAGERIAL ECONOMICS IN THE 21ST CENTURY

4.

5.

6.
7.

8.

not insured by the Philippine Deposit

Insurance Corporation (PDIC). The
moment the bank closes down, the
depositor's money is lost.
Private Banking. Ever wanted to be the VIP
of the party? In a bank, that is possible.
Private banking provides additional resources
and VIP treatments to depositors who have
maintained a certain amount of untouched deposits
with the bank for a specific period. For example,
a bank depositor who maintains at least Php
500,000 average daily balance for six months
with the bank gets to have his/her own queue when
he/she falls in line in the bank to transact.
FCDU Operations. Foreign currency denomination
unit (FCDU) is a function of the bank that deals with
foreign currency. In the Philippines, money deposited to the
bank, which is not in the form of Philippine peso, shall be
managed by the FCDU department.
International Banking. Banks within the country may have either foreign
 counterparts or branches abroad. This function is used to cater to our
friends and relatives overseas. International banking includes the
remittance of money from abroad to our country.
Brokerage. Brokers are professionals who service clients for specific
purposes. Real estate brokers assist in the purchase and sale of real estate
properties, while stock brokers help manage the trading of their clients' stocks.
Banks also have this function as it can serve as brokers of their depositors as well.
Investment Banking or Underwriting. When a business may need to increase its
working capital, banks may lend help by distributing the company bonds on behalf of
this client-company. This can be in the form of either best effort or firm
commitment.
We need to keep in mind that not all banks have all these other functions. They
secure approvals and ensure adequate controls and funds to be capable of serving
these functions. Their functions may also depend on what type of bank they are and the
purpose for which they are established. The most unique of all the banks in the
Philippines is the Al-Amanah Islamic Bank. This is the only Islamic bank in the country
charging interest payments on the money they lend, they
that, instead of
just charge a certain fee for the
transaction.

Types of Bank
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In the Philippines, there are seven major types of bank, namely:

universal banks, commercial banks, thrift banks, rural banks,
cooperative banks, Islamic banks, and digital
banks.

The biggest of all in terms of asset size are universal banks.

bank functions that were mentioned
They serve all the
(so long as they have secured approval from the
government). Their only difference with commercial
banks in terms of the
function would be
underwriting function, which is only permitted
for universal banks.
CHAPTER 8 Money and Monetary Policy
117

Foreign banks in the country are

categorized based on their asset size,
license, a capability, while rural and thrift
banks are smaller in sizes and have
limited functions depending on their
capabilities. They are established to service
smaller institutions and fellow farmers and
those engaged in the agriculture industry.
Some banks were originally
established for agrarian reform funding.

There are a few cooperative banks

operating in the country that specifically
cater more on cooperatives, and one Islamic
bank for our Muslim brothers and sisters.
They have a separate bank mandated by law
because the way they do banking is different from
the common practices being done in the Philippines and in other
countries.
Among all these types of bank, only the Islamic
bank has a different set of practice. Islamic banks are
different because their loans do not have interest but are
governed by a different method of consideration. Only
one Islamic bank exists in the country: Al-
Amanah.

are

The most recent type of bank that has just been approved is digital
banks. These banks that do not have physical offices and
operate online using websites or software applications. They are
accessible via the internet, where all banking transactions transpire.

Central Banking in the Philippines

NOT

To ensure the adequate protection of the public, especially the depositors and
borrowers, the government established the Bangko Sentral ng Pilipinas (BSP). BSP has
been given independence and power to govern all banks and nonbank financial
institutions to maintain monetary stability in the country. It was mandated by the Philippine
government with different roles. Ultimately, the BSP is the supervisor of all banks that
regularly monitors and examines the operations of the banks and their compliance with
banking rules and regulations. These rules and regulations are established by the BSP after
consultation with the banks and their foreign counterparts in central banking. Not only is the
BSP a supervisor, but it is also the bank of banks, making the banks in the
Philippines its clients as the BSP does not deal directly with the public.
The BSP is also the issuer of money. It has the exclusive authority to
issue the national currency. All notes and coins issued are fully guaranteed
by the government and are considered legal tender for all private and public
 authority, as BSP is uniquely qualified to
debts. It is also the monetary
promote price stability because it has the ability to influence the
amount of money and credit conditions in the economy. It employs
the use of monetary policies and different tools to control money
supply.
As the custodian of the country's official reserves, the BSP
maintains an
acceptable

level of reserves to reduce the economy's

vulnerability against global economic risks,
supports the needs of a more dynamic and
globally competitive economy, and preserves
the international convertibility of the Philippine
peso. Lastly, it is known as the lender of
last resort. As the lender of last resort,
the BSP provides loans and advances
to banks in
times of emergencies.

118

MANAGERIAL ECONOMICS IN THE

21ST CENTURY
Monetary
Policy
 As part of the main role of BSP in
regulating banks and in managing money
supply, the
BSP uses different
monetary tools in controlling the
money circulating in the hands of
the public.
Why does BSP need to control the supply of
here. If
money? We can apply a simple lesson
everyone has it, what will make you want
it more? People buy the newest gadget
because it has new features, it is different, and
not everyone likes it. Take the iPhone 10 as an
example. If I will give you an iPhone 10 in
exchange for the most recent cell phone that
Apple or another brand has released (which
you now own), will you be open to trading?
Your answer will probably be no because everyone you
know has an iPhone 10 and you can even have it for free.
open
In the past, the world has witnessed the sudden and significant
decrease in the value of currency from different countries. This
decrease in value is because of inflation. Inflation shall be
discussed in detail in Chapter 11 of this textbook. Thus, if the BSP
wants to increase prices, it decreases money supply, and if it wants to
decrease prices, it increases money supply. It has three different tools that it
uses to control money supply: market operations (OMO), reserve requirements,
and interest rates. When you go to the BSP website, you shall see these two rates:
RP and RRP. RP is the repo rate or repurchase rate. It is the rate at which BSP
sells its securities to the bank. Meanwhile, RRP, or reverse repo rate or reverse
repurchase rate, is the rate at which the banks redeem the BSP-issued instruments. These
rates, depending on which is higher, shall influence banks to either buy or sell the BSP-
issued instruments with them.
If the BSP wants a quick or sudden change at the level of money supply in the
market, it shall make use of the reserve requirements. Banks are required to maintain a
certain percentage of the public's deposit with them to ensure that they have
sufficient working capital. As of this writing, this is currently nailed at 20%. It means that
for every Php 100 deposit that the bank receives, Php 20 stays with them and is
not lent to borrowers.
This level of reserve requirements can be either decreased or increased. If
the central bank wants the money supply to increase, it decreases reserve
the current reserve requirement is 20% and is
requirement. If
decreased to 15%, more money will be available for lending to borrowers
and consequently, more money will circulate in the public. The opposite is
true when the reserve requirement is increased.
The last of these monetary tools is the use of interest rates. As we have
discussed earlier,
banks pay interest to depositors and charge
interests to borrowers. The interest that will be tantamount to
controlling that the banks use is not dictated by the BSP b and
managing the bank itself. What BSP does is to suggest a
level of interest rate that banks can use as a benchmark of
what is normal, regular, or acceptable.
 CHAPTER 8 Money and Monetary Policy
119

Although the BSP is given this much power

(and responsibility), it cannot entirely be
liable in the movement of prices. There are
also tools that the executive department of
the government uses, which may
unintentionally influence money
supply. Two of these are government
expenditures and taxation. If the government
spends more money, more
money is circulated to contractors and the public, thereby increasing
money supply.

Money Creation
028

Another concept connected to banking is the

concept of money creation. The concept of
money creation believes that when money is placed in
banks and financial institutions, it multiplies. When we talk about
money multiplying, it means that its value is increasing.
 Table 8.1. Concept of Money Creation
Bank
New Deposit
20% Reserves
Loans and Investments
1
1,000.00
200
800.00
2
800.00
160.00
640.00
3
640.00
128.00
512.00
4
512.00
102.40
409.60
5
409.60
81.92
327.68
48
0.03
0.01
0.02
49
0.02
0.00
0.02
4,999.91
999.98
3,999.93
If you look at Table 8.1, we can see that Bank 1 has Php 1,000. It reserves its Php 200
based on BSP mandate, and lends out the remaining Php 800. The borrower would deposit
that Php 800 in the bank and the same shall be done by the succeeding banks
to which these amounts are to be deposited to. When we talk about money
creation, it is not all about physically multiplying money. It is a concept that you
may not physically multiply it, but the value it bears, the recorded amounts that it
reflects on the bankbooks, and the number that grows in your bank account
increase in the macro level.
me

At the end of the day, money is just a worthless piece of paper whose
validity comes from government laws and whose value comes from the
amount that results from our demand. Its supply, meanwhile, is
influenced by the BSP, together with the other transactions
 that are done by the government system. Indeed,
without money, we might to trade and try to find
satisfaction in whatever item we will see there, and
hopefully, that still be visiting the market, bringing
with us kitchen wares, yards of silk, and some lamps
includes toiletries.

alde

120

MANAGERIAL ECONOMICS
IN THE 21ST CENTURY
SUMMARY

One of the oldest forms of

money is commodity and fiat
money, while barter was the
oldest means to transfer an item or
property from one person to another.
Banks serve as financial intermediary
between depositors (savers) and
borrowers. This function not only includes
deposit-taking and lending, but also (i)
Treasury Operations, (ii) Borrowings, (iii)
Trust Operations, (iv) Private Banking, (v)
FCDU Operations, (vi) International
Banking, (vii) Brokerage, and (viii)
Investment Banking
or Underwriting.
The Bangko Sentral ng Pilipinas (BSP) is the
entity created by the government to manage
banks and financial institutions in the
Philippines by establishing monetary policies
that include (i) open market operations (OMO), (ii)
reserve requirements, and (iii) interest rates.
In the Philippines, there are different types of bank: (i) universal, (ii)
commercial, (iii) rural, (iv) thrift, (v) cooperative, (vi) digital, and (vii)
one Islamic bank in operation.
 CHAPTER 8 Money and Monetary Policy
121

Name:

Section:
End of Chapter Assessment CHAPTER
8: Money and Monetary Policy

Date:

Part I. True or False. Write TRUE beside the number if the

statement is correct. Otherwise,
write FALSE.

wwwww

1. The concept of money creation means that money is

printed to
create more of its copies.
vods adi to A
2.

3.

A.

5.

6.

7.

8.
FCDU means foreign currency dollar unit.

Trust funds are insured up to 500,000 per account

holder.
Underwriting is not allowed for commercial banks.
 316

As a lender of last resort, a Filipino may borrow directly from the

BSP during emergencies.
2213

As a function of a bank, borrowings and credit are synonymous.

Commercial banks are also known as Islamic banks.

Brokerage is when a bank engages in treasury operations for its clients.

9.
Financial intermediation process is when the bank serves as the "bridge" between the
depositors and borrowers.

10.
All money deposited to banks may be lent to the borrowing public.

Part II. Multiple Choices. Write the letter of the correct answer on the line before the
number.
The function of a bank allowed only for universal banks
1.

A.
Trust
C.
Investment banking

D.
International banking
B.
Private banking

2.
The characteristic of money wherein the people use it to measure the
value goods to be purchased
A. Medium of exchange
C.
Store of value

B. Financial intermediate
D.
Unit of account
 CHAPTER 8 Money and Monetary Policy
123
3.

A.

The monetary policy which has the

fastest effect on money supply once
implemented
Reserve requirement
C.
Interest rate

D.
Money creation
B.
OMO

4.
The smallest type of bank
C.
Digital
A.
Thrift

SibeD.
Islamic
B.
Rural

5.
The following are the functions of the BSP,
EXCEPT:
A.
Custodian of cash

B.
Issuer of money
competitive.
2011
C.
Lender of last resort

D.

All of the above are

 functions

Part III. Reflection Question

wolls do

What have you observed in highly urbanized areas in the Philippines? Do they
have more
number of banks? Why do you think is that so? Discuss.

124
MANAGERIAL ECONOMICS IN THE 21ST
CENTURY