FM 313 Monetary Policy and Central Banking PDF

FM 313 MONETARY POLICY AND CENTRAL BANKING FM MONETARY POLICY AND CENTRAL BANKING 313 NASH N. REGINIO 1|Page  FM 313 MONETARY POLICY AND CENTRAL BANKING Wel...

FM 313 MONETARY POLICY AND CENTRAL BANKING FM MONETARY POLICY AND CENTRAL BANKING 313 NASH N. REGINIO 1|Page  FM 313 MONETARY POLICY AND CENTRAL BANKING Welcome Message I am pleased to welcome you all to this course which focuses on the economics of central banking and the conduct of monetary policy. It focuses on the most important player in financial markets throughout the world: the central banks. Through the conduct of monetary policy, the course will examine the impact of monetary policy to the economy and to the business sector. This course pack is divided into three modules. Module 1 provides an overview of the financial system. The history of Philippine money is discussed in this module to showcase how our social, political, and cultural life are woven into multi-colored threads. Module 2 discusses the structure and organization of the Bangko Sentral ng Pilipinas. A discussion on how the money supply is determined in the economy. What causes it to change, and how might control of it be improved, are some of the questions that this module answers. Module 3 examines the tools of monetary policy used by the BSP to control the money supply and interest rates. It helps you understand how these policy tools has such an important impact on interest rates and economic activity. The modules will aid your quest to learning more about the financial industry and the implications of monetary policy stance on the business environment. You are expected to do a lot of reading, and use the materials you have read in preparing the course requirements. It is my earnest hope that this course will serve you well in your chosen field. I hope you will have a great learning experience this semester. 2|Page  FM 313 MONETARY POLICY AND CENTRAL BANKING Faculty Information: Faculty in-charge: NASH N. REGINIO Office: College of Business Administration Contact Information: [email protected] Consultation hours: Scheduled consultation through email or Messenger Getting help For academic concerns: Nash N. Reginio, MBA For administrative concerns: Dr. Gilbert M. Gordo For UVE concerns (KMD - Contact details) For health and wellness concerns (UAGC, HSD and OSAS - Contact details) 3|Page  FM 313 MONETARY POLICY AND CENTRAL BANKING Course Pack Structure 4|Page  FM 313 MONETARY POLICY AND CENTRAL BANKING Module Intended Learning Outcomes Lessons 1. Discuss the financial system. 2. Appreciate how our social, political, and cultural life are woven into multi-colored threads in the form of money 1. Overview of the financial system 1 Introduction 2. History of Philippine money 1. Describe the structure and organization of the Bangko 1. Organization of the The Bangko Sentral ng Pilipinas BSP 2 Sentral ng 2. Discuss how the money 2. The money supply Pilipinas supply is determined in the process economy. 1. Examine the tools of monetary policy used by the BSP to control the money 1. Inflation targeting supply and interest rates. 2. Other monetary The Tools of 3 operations Monetary Policy 2. Appreciate how these policy tools has such an important 3. Monetary policy across impact on interest rates and the years economic activity 5|Page  FM 313 MONETARY POLICY AND CENTRAL BANKING Module No. & Title MODULE 2 The Bangko Sentral ng Pilipinas This module discusses the structure and organization of the Bangko Sentral ng Pilipinas. A discussion on how the money Module Overview supply is determined in the economy. What causes it to change, and how might control of it be improved, are some of the questions that this module answers. 1. Describe the structure and organization of the Bangko Module Sentral ng Pilipinas Objectives/Outcomes 2. Discuss how the money supply is determined in the economy Lessons in the module 1. Organization of the BSP 2. The money supply process 6|Page  FM 313 MONETARY POLICY AND CENTRAL BANKING Module No. and Title MODULE 2 The Bangko Sentral ng Pilipinas Lesson No. and Title LESSON 1 Organization of the BSP 1. Describe the structure and organization of the Bangko Sentral ng Pilipinas Learning Outcomes 2. Describe the role and functions of the BSP in nation- building. The lesson will take you about an hour and a half to Time Frame complete. Introduction No single economy will flourish without some monetary authority who will regulate money, banking, and credit in the economy. In fact, Sec. 20, Art. XII of the 1987 Philippine Constitution provides that “The Congress shall establish an independent central monetary authority…(which) shall provide policy direction in the areas of money, banking and credit. It shall have supervision over the operations of banks and exercise such regulatory powers as may be provided by law over the operations of finance companies and other institutions performing similar functions.” The purpose of this lesson is to discuss the structure and functions of the country’s central bank, the Bangko Sentral ng Pilipinas. Activity Click the link below and watch the video https://www.youtube.com/watch?v=53fly_5MpEU&list=PL0ytjRCMkSZhnEZiBPMfciA KZD74QJzgs. Then answer the following 1. What are the three pillars of the BSP? Describe each pillar. _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ 2. Discuss the role of the BSP in nation building. _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ 7|Page  FM 313 MONETARY POLICY AND CENTRAL BANKING Analysis  How crucial is the role of the BSP in the economy?  What do you think will happen in the economy if BSP cannot perform its functions effectively?  Based on the activity above, let us the discuss the role of the BSP. Abstraction The BSP The Bangko Sentral ng Pilipinas (BSP) is the central bank of the Republic of the Philippines. It was established on 3 July 1993 pursuant to the provisions of the 1987 Philippine Constitution and the New Central Bank Act of 1993. The BSP took over from the Central Bank of Philippines, which was established on 3 January 1949, as the country’s central monetary authority. The BSP enjoys fiscal and administrative autonomy from the National Government in the pursuit of its mandated responsibilities. Sec. 1, Art. 1, Chap 1 of R.A. 7653, also known as the New Central Bank Act, states that “The State shall maintain a central monetary authority that shall function and operate as an independent and accountable body corporate in the discharge of its mandated responsibilities concerning money, banking and credit. In line with this policy, and considering its unique functions and responsibilities, the central monetary authority established under this Act, while being a government-owned corporation, shall enjoy fiscal and administrative autonomy.” Vision The BSP aims to be recognized globally as the monetary authority and primary financial system supervisor that supports a strong economy and promotes a high quality of life for all Filipinos. Mission To promote and maintain price stability, a strong financial system, and a safe and efficient payments and settlements system conducive to a sustainable and inclusive growth of the economy. Core Values 8|Page  FM 313 MONETARY POLICY AND CENTRAL BANKING Responsibility and Primary Objectives of the BSP It shall be the responsibility of the BSP: 1. To provide policy directions in the areas of money, banking, and credit; 2. To supervise the operations of the banks and to exercise such regulatory and examination powers as provided under Republic Act No. 11211 (The New Central Bank Act, as amended) and other pertinent laws over the quasibanking operations of non-bank financial institutions; and 3. To exercise regulatory and examination powers over money service businesses, credit granting businesses, and payment system operators. Its primary objective is to maintain price stability conducive to a balanced and sustainable growth of the economy and employment. It shall also: 1. Promote and maintain monetary stability and the convertibility of the peso; 2. Promote financial stability and closely work with the National Government, including, but not limited to, the Department of Finance, the Securities and Exchange Commission, the Insurance Commission, and the Philippine Deposit Insurance Corporation; 3. Oversee the payment and settlement systems in the Philippines, including critical financial market infrastructures, in order to promote sound and prudent practices consistent with the maintenance of financial stability; and 4. Promote broad and convenient access to high quality financial services and consider the interest of the general public. 9|Page  FM 313 MONETARY POLICY AND CENTRAL BANKING History of the Bank A group of Filipinos had conceptualized a central bank for the Philippines as early as 1933. It came up with the rudiments of a bill for the establishment of a central bank for the country after a careful study of the economic provisions of the Hare-Hawes Cutting bill, the Philippine independence bill approved by the US Congress. During the Commonwealth period (1935-1941), the discussion about a Philippine central bank that would promote price stability and economic growth continued. The country’s monetary system then was administered by the Department of Finance and the National Treasury. The Philippines was on the exchange standard using the US dollar—which was backed by 100 percent gold reserve—as the standard currency. In 1939, as required by the Tydings-McDuffie Act, the Philippine legislature passed a law establishing a central bank. As it was a monetary law, it required the approval of the United States president. However, President Franklin D. Roosevelt disapproved it due to strong opposition from vested interests. A second law was passed in 1944 during the Japanese occupation, but the arrival of the American liberalization forces aborted its implementation. Shortly after President Manuel Roxas assumed office in 1946, he instructed then Finance Secretary Miguel Cuaderno, Sr. to draw up a charter for a central bank. The establishment of a monetary authority became imperative a year later as a result of the findings of the Joint Philippine-American Finance Commission chaired by Mr. Cuaderno. The Commission, which studied Philippine financial, monetary and fiscal problems in 1947, recommended a shift from the dollar exchange standard to a managed currency system. A central bank was necessary to implement the proposed shift to the new system. Immediately, the Central Bank Council, which was created by President Manuel Roxas to prepare the charter of a proposed monetary authority, produced a draft. It was submitted to Congress in February1948. By June of the same year, the newly-proclaimed President Elpidio Quirino, who succeeded President Roxas, affixed his signature on Republic Act No. 265, the Central Bank Act of 1948. The establishment of the Central Bank of the Philippines was a definite step toward national sovereignty. Over the years, changes were introduced to make the charter more responsive to the needs of the economy. On 29 November 1972, Presidential Decree No. 72 adopted the recommendations of the Joint IMF-CB Banking Survey Commission which made a study of the Philippine banking system. The Commission proposed a program designed to ensure the system’s soundness and healthy growth. Its most important recommendations were related to the objectives of the Central Bank, its policy-making structures, scope of its authority and procedures for dealing with problem financial institutions. Subsequent changes sought to enhance the capability of the Central Bank, in the light of a developing economy, to enforce banking laws and regulations and to respond to emerging central banking issues. Thus, in the 1973 Constitution, the National Assembly was mandated to establish an independent central monetary authority. Later, PD 1801 designated the Central Bank of the Philippines as the central monetary authority (CMA). Years later, the 1987 Constitution adopted the provisions on the CMA from the 1973 Constitution that were aimed essentially at establishing an independent monetary authority through increased capitalization and greater private sector representation in the Monetary Board. 10 | P a g e  FM 313 MONETARY POLICY AND CENTRAL BANKING The administration that followed the transition government of President Corazon C. Aquino saw the turning of another chapter in Philippine central banking. In accordance with a provision in the 1987 Constitution, President Fidel V. Ramos signed into law Republic Act No. 7653, the New Central Bank Act, on 14 June 1993. The law provides for the establishment of an independent monetary authority to be known as the Bangko Sentral ng Pilipinas, with the maintenance of price stability explicitly stated as its primary objective. This objective was only implied in the old Central Bank charter. The law also gives the Bangko Sentral fiscal and administrative autonomy which the old Central Bank did not have. On 3 July 1993, the New Central Bank Act took effect. Organizational Structure Monetary Board Governor Monetary and Financial Corporate Economics Supervision Services Sector Sector Sector The Monetary Board exercises the powers and functions of the BSP, such as the conduct of monetary policy and supervision of the financial system. Its chairman is the BSP Governor, with five full-time members from the private sector and one member from the Cabinet. The Governor is the chief executive officer of the BSP and is required to direct and supervise the operations and internal administration of the BSP. A deputy governor (or a Senior Assistant Governor in the case of the Currency Management Sector) heads each of the BSP's operating sector as follows: Monetary and Economics Sector is mainly responsible for the operations/activities related to monetary policy formulation, implementation, and assessment Financial Supervision Sector is mainly responsible for the regulation of banks and other BSP-supervised financial institutions, as well as the oversight and supervision of financial technology and payment systems Corporate Services Sector is mainly responsible for the effective management of corporate strategy, communications, and risks, as well as the BSP's human, financial, technological, and physical resources to support the BSP's core functions 11 | P a g e  FM 313 MONETARY POLICY AND CENTRAL BANKING The Monetary Board In the exercise of its authority, the Monetary Board shall: a. issue rules and regulations it considers necessary for the effective discharge of the responsibilities and exercise of the powers vested upon the MB and the BSP. The rules and regulations issued shall be reported to the President and Congress within fifteen (15) days from the date of the issuance; b. direct the management, operations, and administration of the BSP, reorganize the personnel, and issue such rules and regulations as it may be deem necessary or convenient for this purpose. The legal units of the BSP shall be under the exclusive supervision and control of the MB. c. establish a human resource management system which shall govern the selection, hiring, appointment, transfer, promotion, or dismissal of all personnel. Such system shall aim to establish professionalism and excellence of the BSP in accordance with sound principles of management. A compensation structure, based on job evaluation studies and wage surveys subject to the Board's approval, shall be instituted as an integral component of the Bangko Sentral's human resource development program. On the recommendation of the Governor, appoint, fix the remunerations and other emoluments, and remove personnel of the Bangko Sentral, subject to pertinent civil service laws: Provided, that the Monetary Board shall have exclusive and final authority to promote, transfer, assign, or reassign personnel of the Bangko Sentral and these personnel actions are deemed made in the interest of the service and not disciplinary: Provided, further, that the Monetary Board may delegate such authority to the Governor under such guidelines as it may determine; d. Adopt an annual budget for such expenditures by the BSP as are in the interest of the effective administration and operations of the BSP in accordance with applicable laws and regulations; and e. Indemnify its members and other officials of the BSP, including personnel of the departments performing supervision and examination functions against all costs and expenses reasonably incurred by such persons in connection with any civil or criminal action, suit or proceedings to which he may be, or is, made a party by reason of the performance of his functions or duties, unless he is finally adjudged in such action or proceeding to be liable for willful violation of Republic Act 11211, performed in evident bad faith or with gross negligence. 12 | P a g e  FM 313 MONETARY POLICY AND CENTRAL BANKING Powers and Duties of the Governor Pursuant to Republic Act No. 7653 (The New Central Bank Act), the Governor shall be the Chief Executive Officer of the Bangko Sentral. His powers and duties shall be to: a. prepare the agenda for the meetings of the Monetary Board and to submit for the consideration of the Board the policies and measures that he believes to be necessary to carry out the purposes and provisions of said Act; b. execute and administer the policies and measures approved by the Monetary Board; c. direct and supervise the operations and internal administration of the Bangko Sentral. The Governor may delegate certain of his administrative responsibilities to other officers or may assign specific tasks or responsibilities to any fulltime member of the Monetary Board without additional remuneration or allowance whenever he may deem fit or subject to such rules and regulations as the Monetary Board may prescribe; d. appoint and fix the remunerations and other emoluments of personnel below the rank of a department head in accordance with the position and compensation plans approved by the Monetary Board, as well as to impose disciplinary measures upon personnel of the Bangko Sentral, subject to the provisions of Section 15(c) of said Act: Provided, That removal of personnel shall be with the approval of the Monetary Board; e. render opinions, decisions, or rulings, which shall be final and executory until reversed or modified by the Monetary Board, on matters regarding application or enforcement of laws pertaining to institutions supervised by the Bangko Sentral and laws pertaining to quasi-banks, as well as regulations, policies or instructions issued by the Monetary Board, and the implementation thereof; and f. exercise such other powers as may be vested in him by the Monetary Board. The Governor of the Bangko Sentral shall be the principal representative of the Monetary Board and of the Bangko Sentral and, in such capacity and in accordance with the instructions of the Monetary Board, he shall be empowered to: 1. represent the Monetary Board and the Bangko Sentral in all dealings with other offices, agencies and instrumentalities of the Government, and all other persons or entities, public or private, whether domestic, foreign or international; 2. sign contracts entered into by the Bangko Sentral, notes and securities issued by the Bangko Sentral, all reports, balance sheets, profit and loss statements, correspondence, and other documents of the Bangko Sentral; 3. represent the Bangko Sentral, either personally or through counsel, including private counsel, as may be authorized by the Monetary Board, in any legal proceedings, action or specialized legal studies; and 4. delegate his power to represent the Bangko Sentral, to other officers upon his own responsibility: Provided, however, That in order to preserve the integrity and the prestige of his office, the Governor of the Bangko Sentral may choose not to participate in preliminary discussions with any multilateral banking or financial institution on any negotiations for the Government within or outside the Philippines. During the negotiations, he may instead be represented by a permanent negotiator. 13 | P a g e  FM 313 MONETARY POLICY AND CENTRAL BANKING The BSP Governor acts as the Chairman of the AMLC, which was created pursuant to Republic Act (R.A.) No. 9160, otherwise known as the “Anti-Money Laundering Act of 2001” (AMLA), to protect the integrity and confidentiality of bank accounts and to ensure that the Philippines shall not be used as a money laundering site for the proceeds of any unlawful activity. The Council performs its functions through the AMLC Secretariat, which is primarily tasked to receive transaction reports from covered institutions, investigate suspicious transactions, and cause the filing of complaints or petitions for the prosecution of money laundering offenses and other AMLA violations. Section 8 of R.A. No. 9160 provides that all members of the AMLC Secretariat shall hold full-time permanent positions within the BSP. The 3 Pillars of Central Banking – its Core Mandates 1. Price Stability. The BSP's main responsibility is to formulate and implement policy in the areas of money, banking and credit with the primary objective of preserving price stability. Price stability refers to a condition of low and stable inflation. By keeping price stable, the BSP helps ensure strong and sustainable economic growth and better living standards. 2. Financial Stability. Financial systems play a critical role for consumers – both corporates and individuals – because they bridge the aspirations of today with the economic fortunes of tomorrow. Historically, financial systems develop through the banking industry because of the nature of fiat money. In this context, making sure that banks operate in a safe and sound manner is in the public interest. Banks, after all, manage our savings, offer critical services in the transfer of funds and the payment of obligations, while providing a venue for entrepreneurs to pursue their economic plans through credit. Banking authorities nurture this by defining the regulatory framework that encourages innovation while monitoring that banks operate within prescribed governance guidelines. The Global Financial Crisis (GFC), however, highlighted how the financial system is more than just the sum of its parts. There is a unique sense of “systemic-ness” that arises from the way each market player interacts with another party, creating a network of interconnected and sequenced transactions. This leads to risk choices being interlinked within the network and as a result, societal outcomes that can differ from the intentions of private entities. This provides the basis for the global initiative to manage the health of the financial system as an explicit and separate policy objective. Its focus is on managing so-called “systemic risks” and this is done through macroprudential policy. 14 | P a g e  FM 313 MONETARY POLICY AND CENTRAL BANKING 3. Efficient Payments and Settlements System. Payment systems are essential to the effective functioning of financial systems worldwide. They provide the channels through which funds are transferred among banks and other institutions to discharge payment obligations arising from economic and financial transactions across the entire economy. An efficient, secure and reliable payment system reduces the cost of exchanging goods and services, and it is an essential tool for the effective implementation of monetary policy, and the smooth functioning of money and capital markets. It is this key role played by payment and settlement system (PSS) in the smooth functioning of an economy in general and its financial and monetary system in particular that gives the central bank (CB) a strong incentive for ensuring that an effective, reliable and secure payment and settlement system is in place. In the Philippines, the BSP takes the lead in promoting an efficient payments and settlements system by providing: a. the necessary infrastructure through the operations of the Philippine Payment and Settlement System or the “PhilPaSS”; and b. a policy and regulatory framework, also known as the National Retail Payment System or NRPS, to establish safe, efficient and reliable retail payment system in the country. The BSP performs the following role in the payments and settlements system:  Operator of the real time gross settlement system known as PhilPaSS. The BSP, through its Payments and Settlements Office (PSO), serves as the payment system operator responsible for the operation and maintenance of PhilPaSS and its critical components. It ensures that the operation of PhilPaSS is continuous, safe and efficient so that time-critical payments are completed as expected to facilitate and enhance economic processes, manage risks, and absorb shocks in order to promote financial stability.  Provider of credit facilities to banks as a lender of last resort As payment systems affect the daily demand for liquidity of banks/financial institutions and may therefore affect the level of money market interest rates, the BSP, as a lender of last resort, provides the following liquidity tools to PhilPaSS participants: i. Intraday Liquidity Facility (ILF) – a fully collateralized facility established to maintain the smooth and efficient operation of the payments system in order to avoid interbank payments gridlock in the settlement process within PhilPaSS business hours. ii. Overdraft Credit Line (OCL) – another collateralized facility which aims to assist bank experiencing unexpected or higher than usual volume of inward check transactions. The governing policies and procedures are provided under BSP Circular 681 in order to provide additional liquidity for banks encountering liquidity problems due to check clearing losses as well as protect the BSP against settlement exposures. 15 | P a g e  FM 313 MONETARY POLICY AND CENTRAL BANKING  Overseer of the payments and settlements system The BSP, through the Payment Systems Oversight Department of the Supervision and Examination Sector, oversees the payment systems in the country to ensure safeguards are in place to mitigate systemic risks arising from settlement, credit and liquidity risks of payments and settlement systems participants.  User of its own RTGS system The BSP, through its different departments, also make use of the payments and settlements system for the settlement of its own transactions with its stakeholders, such as:  The automated collection and settlement of Supervision and Examination Sector annual supervisory fees;  Online processing of eRediscounting loan proceeds and collection of banks’ maturing loans with Department of Loans and Credit;  Processing/posting of banks’ cash deposit and withdrawal transactions with Cash Department;  Investment/maturities of funds placed by the Provident Fund Office; and  Trading transactions as well as payments of maturing RRP/SDA placements with Treasury Department  Initiate changes/reforms for the payments system The BSP initiates the conduct of studies/research relating to payments system to ensure that it grows and matures in accordance with the global standards. Among the studies conducted which initiated reform to the retail payment systems in the country is the National Retail Payment System. Application Go to https://www.bsp.gov.ph/Media_And_Research/BSP%20Comic%20Series/comics4.pdf and read the comics that talks about inflation and the importance of price stability. Why price stability is important for you and the economy as a whole? Answer should not be shorter than 10 sentences but no more than 15 sentences. Well done! You are now ready to proceed to the next lesson about the Money Supply Process. 16 | P a g e  FM 313 MONETARY POLICY AND CENTRAL BANKING Module No. and Title MODULE 2 The Bangko Sentral ng Pilipinas Lesson No. and Title LESSON 2 The Money Supply Process 1. Describe the factors affecting the BSP’s assets and liabilities. 2. Describe the impact of the movements in money supply Learning Outcomes to the overall health of the economy. 3. Discuss how the money supply is determined in the economy. The lesson will take you about an hour and a half to Time Frame complete. Introduction You may have learn in one of your introductory courses the effects on interest rates and on the overall health of the economy when money supply changes. And such impacts affect all of us. It is important for us to understand how the money supply is determined. Who controls it? What causes it change? How might control of it be improved? These are some of the questions that we will answer by providing a detailed description of the money supply process, the mechanism that determines the level of the money supply. This lesson provides an overview of how the banking system creates deposits, and describes the basic principles of the money supply Activity Answer the following. 1. How important it is for an individual to have savings? _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ 2. How important savings are to the overall health of the economy? _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ Analysis  How money is circulated in the economy?  How does savings create more money ?  Based on the activity above, let us the discuss the money supply process. 17 | P a g e  FM 313 MONETARY POLICY AND CENTRAL BANKING Abstraction Three Players in the Money Supply Process 1. Central bank – the government agency that oversees the banking system and is responsible for the conduct of monetary policy. 2. Banks and other depository institutions – the financial intermediaries that accept deposits from individuals and institutions and make loans: commercial banks, savings and loan associations, mutual savings banks, and credit unions. 3. Depositors – individuals and institutions that hold deposits in banks Of the three, the central bank is the most important. The CB’s conduct of monetary policy involves actions that affect its balance sheet. The BSP’s Balance Sheet The operation of the BSP and its monetary policy involve actions that affect its balance sheet, its holdings of assets and liabilities. A simplified balance sheet that includes just four items that are essential to our understanding of the money supply process is presented below: BANGKO SENTRAL NG PILIPINAS Assets Liabilities Domestic securities Currency issued Loans and advances Deposits Liability The two liabilities on the balance sheet, currency issued and deposits, are an important part of the money supply process, because increases in either or both will lead to an increase in the money supply, assuming everything else being constant.  Currency issued. This is the currency in circulation or the amount of currency in the hands of the public. BSP banknotes are IOUs from the BSP to the bearer and are also liabilities, but unlike most, they promise to pay back the bearer solely with BSP banknotes; that is, they pay off IOUs with other IOUs. As a matter of fact, you can find this in any of your banknotes: “Ang salaping ito ay bayarin ng Bangko Sentral at pananagutan ng Republika ng Pilipinas” (This note is a liability of the central bank and is guaranteed by the government of the Republic of the Philippines). Simply put, if you bring a 100-piso banknote to the bank and demand payment, you will receive two P50s, five P20s, ten P10s, one hundred 1-piso, or some other combinations of banknotes and coins that adds to 100-piso.  Deposits. All banks have an account at the BSP in which they hold deposits, also called as reserve deposits. These consist of deposits at the BSP plus currency that is physically 18 | P a g e  FM 313 MONETARY POLICY AND CENTRAL BANKING held by banks called vault cash because it is stored in bank vaults. Reserves are assets for the banks but liabilities BSP is required to satisfy its obligation by paying BSP banknotes. Note that an increase in reserves leads to an increase in the level of deposits and hence in the money supply. Generally, a central bank’s reserves can be categorized into two: required reserves, or the reserves that the central bank requires banks to hold, and excess reserves, or any additional reserves the banks choose to hold. Assets The two assets on the BSP’s balance sheet are important for two reasons. First, changes in the asset items lead to changes in reserves and consequently to changes in the money supply. Second, because these assets earn interest while the liabilities (esp. currency issued and reserves) do not, the BSP makes money out of it—its assets earn income, and its liabilities cost nothing.  Domestic securities. This covers its holdings of BSP securities. Open market operations of the BSP will be tackled later. As you will see, the central bank provides reserves to the banking system by purchasing securities, thereby increasing its holdings of these assets. An increase in securities held by the BSP leads to an increase in the money supply.  Loans and advances. The BSP can provide reserves to the banking system by making loans and advances to banks. An increase in loans and advances can also be the source of an increase in the money supply. BSP Open Market Operations Monetary operations refer to the buying/selling of government securities, lending/borrowing against underlying assets as collateral, acceptance of fixed-term deposits, foreign exchange swaps, and the use of other monetary instruments of the Bangko Sentral aimed at influencing the underlying demand and supply conditions for central bank money. Thus, through OMO, the BSP cause changes in the monetary base. One type of OMO that influences the money supply is the reverse repurchase/repurchase transaction. Reverse Repurchase/Repurchase Transactions In a repurchase transaction, the BSP buys government securities (GS) from a bank with a commitment to sell them back at a specified future date at a predetermined rate, resulting in an expansionary effect on liquidity. Conversely, in a reverse repurchase (RRP) operation, the BSP also acts as the seller of GS and the bank’s payment to the BSP has a contractionary effect on liquidity. 19 | P a g e  FM 313 MONETARY POLICY AND CENTRAL BANKING Suppose the BSP buys P100 million of government secruties (repurchase transaction) from a bank. To understand the consequences of this transaction, we look at T-accounts, which list only the changes that occur in balance sheet items, starting from the initial balance sheet position. When the primary dealer sells the P100 million of securities to the BSP, the BSP adds P100 million to the banks deposit account at the BSP, so that reserves in the banking system go up by P100 million. The banking system’s T-account after this transaction is BANKING SYSTEM Assets Liabilities Securities -P100M Loans and advances +P100M The effects on the central bank’s balance sheet are shown next. The balance sheet shows an increase of P100 million of securities in its assets column, along with an increase of P100 million of reserves in its liabilities column: CENTRAL BANK Assets Liabilities Securities +P100M Deposits +P100M As you can see, the above transaction resulted to an expansion of reserves in the banking system by an equal amount. Suppose that central bank sells $100 million of government securities to a bank (reverse repurchase), the central bank deducts P100 million from the bank’s deposit account, so the central bank’s reserves (liabilities) fall by P100 million (and the monetary base falls by the same amount). The T-account is now CENTRAL BANK Assets Liabilities Securities -P100M Deposits -P100M 20 | P a g e  FM 313 MONETARY POLICY AND CENTRAL BANKING Shifts from Deposits into Currency Even when the BSP does not conduct open market operations, a withdrawal of the general public from their deposit accounts will affect the reserves in the banking system. Note, however, that such shift from deposits into currency does not change the monetary base (i.e., the BSP’s monetary liabilities). Further, this tells us that the central bank has more control over the monetary base than over reserves (Mishkin, 2019). Suppose that during the Christmas season, the general public wants to hold more banknotes to spend for gifts, thus withdraws P100 million in cash. The effect on the T-account of the public is PUBLIC Assets Liabilities Bank deposits -P100M Cash +P100M The banking system loses P100M of deposits and therefore P100M of reserves BANKING SYSTEM Assets Liabilities Reserves -P100M Deposits -P100M For the central bank, the public spending means that P100 million of additional currency is circulating in the hands of the public, while reserves in the banking system have fallen by P100 million. The central bank’s T-account is CENTRAL BANK Assets Liabilities Currency issued +P100M Deposits -P100M 21 | P a g e  FM 313 MONETARY POLICY AND CENTRAL BANKING Note that the monetary base is not affected by the general public’s increased demand for currency. But reserves are affected as a result of a shift from deposits to currency. Random fluctuations of reserves can occur as a result of random shifts into currency and out of deposits, and vice versa. The same is not true for the monetary base, making it a more stable variable and more controllable by the central bank. Loans to Financial Institutions Monetary base is also changed when the central banks makes a loan to financial institutions. For example, when BSP makes a P100 million loan to Bank A, the bank is credited with P100 million reserves from the proceeds of the loan. The effects on the balance sheets of the banking system and the central bank are illustrated by the following T-accounts: BANKING SYSTEM CENTRAL BANK Assets Liabilities Assets Liabilities Reserves +P100M Loans +P100M Loans +P100M Deposits +P100M The monetary liabilities of the central bank have now increased by P100 million, and the monetary base, too, has increased by this amount. However, if a bank pays off a loan from the central bank, thereby reducing its borrowings from the central bank by P100 million, the T-accounts of the banking system and the central bank are as follows: BANKING SYSTEM CENTRAL BANK Assets Liabilities Assets Liabilities Reserves -P100M Loans -P100M Loans -P100M Deposits -P100M The net effect on the monetary liabilities of the central bank, and hence on the monetary base, is a reduction of P100 million. We see that the monetary base changes in a one-to- one ratio with the change in the borrowings from the central bank. 22 | P a g e  FM 313 MONETARY POLICY AND CENTRAL BANKING Multiple Deposit Creation What has been presented so far is a simplified presentation on how the BSP controls the monetary base through its conduct of open market operations and loans to financial institutions. Thus, this tells us how money is created and supplied in the economy. What happens now if the BSP supplies the banking system with P1000 of additional reserves? Surely, deposits increase by a multiple of this amount – a process called multiple deposit creation. Read chapter 15 of Mishkin (p 395-407) for a detailed discussion of this topic. Application 1. Go to https://www.bsp.gov.ph/SitePages/PriceStability/MonetaryPolicyDecision.aspx and find the most two recent monetary policy reports of the BSP. Read these reports and write a one-page summary of the differences in these reports. Discuss as well the bases of its decisions. 2. Go to https://www.bsp.gov.ph/SitePages/Statistics/Statistics.aspx and find the historical report of M1, M2, M3, and M4 by clicking on the “Financial/Monetary Account” under Monetary, External and Financial Statistics. Then click Depository Corporations Survey. Requirements: A. Define each component of the monetary/liquidity aggregates. B. Compute the growth rate of each aggregate over each of the past two years. C. Does it appear that the BSP has been increasing or decreasing the rate of growth of the money supply? D. Is this consistent with your understanding of the needs of the economy? Why? Congratulations! You just finished Module 2.Great job! 23 | P a g e  FM 313 MONETARY POLICY AND CENTRAL BANKING MODULE SUMMARY  The Bangko Sentral ng Pilipinas (BSP) is the central bank of the Republic of the Philippines.  Its primary objective of the BSP is to maintain price stability conducive to a balanced and sustainable growth of the economy and employment.  The BSP is headed by a governor who shall be the Chief Executive Officer.  The three 3 Pillar of central banking are price stability, financial stability, and efficient payments and settlements system.  The three players of the money supply process are the central bank, depository institutions, and the depositors. Of the three, central bank is the most important player.  The operation of the BSP and its monetary policy involve actions that affect its balance sheet, its holdings of assets and liabilities.  Four items in the BSP’s balance sheet are essential to our understanding of the money supply process: the two liability items, currency issued and deposits (in the form of reserves), which together make up the monetary base; and the two asset items, securities and loans and advances to financial institutions. REFERENCES https://www.bsp.gov.ph Mishkin, F.S. (2019). The economics of money, banking, and financial markets. Pearson 24 | P a g e