Midterm Flashcards
It is a general statement that describes the causes of changes in financial variables, such as money supply and interest rates, and the effects of these changes, changes in variables, in the real sector, such as employment, production and prices.
Monetary theory
It refers to the amount of goods or services which will be given in exchange for a unit of money.
The Value of Money
It is synonymous with its power to purchase economic goods.
The Value of Money
Prices and the value of money are, thus, ___.
Related
As abrupt changes in the value of money affects the economy, the government finds it necessary to manage the ___. The need for an effective ___ follows. ___, however, is formulated based on some theories about money.
monetary system
Monetary Policy
important theories about money are:
- The Quantity Theory of Money
- The Income Theory
- The Transactions Theory, and
- The Cash-Balance Theory
It is “a theory that states the relationship between the quantity of money in an economy and the price level.’
The Quantity Theory of Money
When the other factors are constant, a change in the quantity of money will result in proportional changes in the price level.
The Quantity Theory of Money
If, for instance, money is increased by 20 percent during a period, prices would be expected to rise by an average of 20 percent also.
The Quantity theory of Money
It was first developed in the late 1500s when money was primarily a medium of exchange used to purchase commodities. If there is more money in circulation, more spending will be made, and with less money, less spending.
The Quantity Theory
It suggests that inflation can be controlled by the monetary authorities through control of the quantity of money in circulation. Thus, if a certain rate of growth in gross national product is anticipated, this can be achieved without inflation by allowing the quantity of money in circulation to increase proportionately.
The Quantity Theory of Money
Formula of Quantity Theory
P = MV/T
P =
The Price level
M
the amount of money in circulation
V=
the velocity of circulation or the rate of money turnover
is that money which is being used to finance transaction, as opposed to idle or inactive money.
The Money in Circulation
It refers to the rate at which money circulated through the economy in order to finance transactions.
The Velocity of Circulation
T =
total volume of trade
Formula for Velocity
V = Y/M
Y
W
M =
the money supply available in the economy for a specified period (Usually 1 year)
V =
the money value of national income over that period.
It is an expression of a belief by some economists about the relationship between income and money.
The Income Theory
They thought that “changes in the value for money or price levels” but through the interaction of the various aggregates like income, investments, savings and consumptions.
The Income Theory
The theory recognizes that one person’s spending is another’s income and in analyzing the value of money, one must focus on the factors that affect income and spending in the economy.
The Income Theory
This simply means that a person with an income will have a means to spend, and when he does, somebody is provided with an income, who in turn, is in a position to spend and provide another with an income.
The Income Theory
This will bring us the need for a brief understanding of the aggregates composing the national income.
The Income Theory
It refers to the value of income form the sales of goods and services in a country.
National Income
It includes not only the income which arise from production within the economy, but also income which accrues to domestic residents from activities carried on abroad.
National Income
National Income can be calculated in 3 ways
As the value of the outputs of all goods and services in the economy, net of indirect taxes and subsidies, and corrected for inter-industry sales so as to avoid double-counting.
As the total flow of incomes paid out to households in return for the supply of production services, plus profits retained by firms as reserves.
As the sum of expenditures on consumers’ goods and investment goods, government expenditures, and expenditures by foreigners on the nation’s exports less domestic expenditures on imports.
It is the expenditure on real capital goods which refer to physical goods.
Investments
Investments does not include the following:
Investments of commercial banks and other financial institutions in terms of purchases of securities; and
Purchases of existing capital goods like a seven year old school building
For purposes of national income analysis, __ will mean spending for new capital goods like constructing a new school building.
Investment
It will result to increased income for construction workers who will build the facility. It will also result to income producers of school supplies, publishers of books, and printers of enrollment forms and class cards.
Investment
As __ expenditures fluctuate, some tools of monetary policy must be used by the central monetary authority to influence the total amount of such expenditures.
investment
It refer to the part of income not spent on consumption.
Savings
It represent money which, having been paid out as income to households by business firms or the government is not returned to them in the form of expenditure on goods and services
Savings
It refers to the total expenditure in an economy on goods and services which are used up within a specified, usually short, period of time, generally a year.
Consumption
This expenditure will include consumer goods and services, as well as raw material and other inputs used in the production process.
Consumption expenditures
Changes in the consumption expenditures are affected by the ff:
Changes in the holdings of money by the individual members of the public;
Changes in the availability of credit and the effective rates of interest;
Changes in the perception of the consumers regarding their current purchasing power.
It is a circular flow of income with business firms and consumers as the main propellers.
The income stream
Businesses provide income to consumers in the form of:
Wages Interest Rent Dividends Royalties
When consumers receive income, they are faced with two options:
To spend on consumption
To save
Circular flow of income
Business firms pays investments then provide Income payments wages, rent, interest, royalty, dividends to consumers which serves as consumption to business firms
It indicates that the value of money is determined by the forces of supply and demand over a period of time, rather than at a given time in a given market.
The transactions approach
The approach focuses on the spending of money
The transactions approach
The proponent of the transactions approach, ___, agrees that “one of the normal effects of an increase in quantity of money is an exactly proportional increase in the general level of prices.”
Irving Fischer
The foregoing statement, according to Fischer, hinges on three assumptions, the validity of which confirms the validity of the quantity theory:
That changes in the quantity of money do not affect velocity;
That changes in the quantity of money do not affect the volume of transactions;
The chain of causation run from money to prices and not in the other direction.
It is a version of the quantity theory of money that focuses on the demand for money.
Cash-balances approach
The approach relates determination of the value of money to the motives and decisions of individuals holding money.
Cash-balances approach
It involves the manipulation of financial variables by the central monetary, authority in order to achieve the economy’s ultimate goals of full employment and balanced economic growth, at stable prices.
Monetary policy
It is viewed as an instrument to stabilize the economy.
Monetary policy
It is a major instrument of macroeconomic policy, which government conducts through the management of the nations money, credit and banking system.
Monetary policy
___use various tools to implement monetary policy. These tools are as follows:
Central monetary authorities
Open market operations
Discount policy
Reserve requirements
It refer to the central bank’s activity of buying or selling of government securities in the open market.
Open market operations
This tool is used to effect changes in interest rates.
Open market operations
Open Market Operations consists of two types as follows:
Dynamic open market operations
Defensive open market operations
those which are intended to change the level of reserves and the monetary base
Dynamic open market operations
those which are intended to offset movements in other factors that affect reserves and the monetary base.
Defensive open market operations
It is a tool used by the Bangko Sentral ng Pilipinas(BSP).
Open Market Operations
This activity is made possible through the sate of BSP holdings of Treasury securities.
Open market operations
Open market operations have the following advantages over the tools of monetary policy:
The BSP has complete control over the volume of transactions. The BSP demonstrated that power once when it partially rejected some bids for its T-bill offerings to arrest an abrupt appreciation in the yields of such financial instrument.
They are flexible and precise and can be used to any extent. If only a small change in reserves or monetary base is required, the central bank can achieve it with small sale or purchase of securities. If a big change is needed, a large sale or purchase is made.
Mistakes can easily be corrected if the central bank feels that the rate of government securities purchased is too low, it can reverse the error by conducting open market sales.
The implementation of open market operations can be made quickly, involving no delays in administration. To change the monetary base or reserves, the central bank will just place orders with securities dealers, and the transactions are effected immediately.
The central bank lends money to ___. The interest rate charged to the borrowers is called the ___
discount rate
depository institutions
Any increase in the discount loans __ to the monetary base and results to an ___ money supply.
Adds
Expanded
Any decrease in discount loans ___ the monetary base which results to a __ money supply.
Reduces
Reduced
The volume of discount loans granted may be achieved by the central bank through any of the following measures:
By affecting the discount rate
By affecting the quantity of the loans
It refer to the regulation making it obligatory for depository institutions to keep a certain fraction of their deposits in accounts with the central bank exercise more precise control over the money supply.
Reserve requirements
Effects of the discount policy:
Discount policy
Discount loans (Any increase, Any decrease)
Any increase results to bigger monetary base and expanded money supply
Any decrease results to a smaller monetary base and shrinking monetary base
Monetary policy is not an end in itself, rather, it is a means to various ends. These ends are called ___
The goals consist of the following:
goals of monetary policy High employment Economic growth Stable prices Interest-rate stability Stability of financial markets Stability in foreign exchange markets
