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8/12/2019 Money Theories, Money and Monetary Policy
http://slidepdf.com/reader/full/money-theories-money-and-monetary-policy 1/33
MONETARY THEORIES
8/12/2019 Money Theories, Money and Monetary Policy
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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 differentfunctions affect the production, distribution and
consumption of goods.
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The Printing Press Cure
Pledging for the foreseeable future to pump
vast sums into banks, other financial firms,
businesses and households.
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Irving Fisher (1867-1947)
A mathematician
turned economist
from Yale.
Published severalhighly successful
mathematical
textbooks.
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Fisher’s 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.
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Fisher’s Equation of Exchange
MV + M’V’ = 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.
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Fisher’s 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.
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Friedman’s 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.
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Milton Friedman (1912-2006)
Was a leading
monetarist
Economics
professor at theUniversity of
Chicago
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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.
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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.
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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.
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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.
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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 tohold assets in the form of money.
The schedule relating the demand for money
to the interest rate is called the liquidityreference schedule.
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MONEY AND MONETARYPOLICY
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Function of Money
As a medium of exchange
1A3C
2B
To restate the role of
money, money serves as
a vehicle for the free flowof products to satisfy
human wants since it can
be exchanged with any
product available in the
market as a commonthing of value.
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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.
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Savings Deposits
Time Deposits
Deposits Substitutes- deposits in savings
banks, savings and loan associations and
even in credit unions.
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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 includessavings and time deposits sometimes called
quasi-money.
M2 = M1 + time + savings deposits
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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 depositsubstitutes.
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)
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Banks and Money Supply
The Fractional Reserve System
- enables commercial banks to lend more
than their reserves.
- they do so by creating more demanddeposits which can circulate like money in
the form of checks while supported by
smaller cash amount to only meetfractional cash demand.
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Money Creation
Commercial banks create moremoney by lending more demand
deposits.
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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.
Functions of the Central Bank
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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.
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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 therepublic to achieve monetary stability and
create conditions conducive to economic
development.
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P = F/ (1+r)
Where:
P = Present Value
F = Future Value
r = Discount rate
n = Number of years back from maturity to
purchase
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Open-market operations - buying and selling
treasury bonds, notes, and bills.
When the Federal Reserve sells moretreasury securities than it buys:
Money Supply Decreases
When the Federal Reserve buys more
treasury securities than it sells:
Money Supply Increases
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- THE
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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 issuedby 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.
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1.Monetary Theory
2. Irving Fisher
3. Monetary Economics
4-6. (1) volume of currency in circulation, (2) velocity ofcirculation, (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