Module in Monetary Policy and Central Banking PDF

MODULE in Monetary Policy And Central Banking Credit to Fajardo and Mejorada  INTRODUCTION This module is an introduction to fundamentals and principles of Monetary Policy and Central Banking. This contains concept, information and acti...

MODULE in Monetary Policy And Central Banking Credit to Fajardo and Mejorada  INTRODUCTION This module is an introduction to fundamentals and principles of Monetary Policy and Central Banking. This contains concept, information and activities to assess students’ knowledge and understanding in Monetary Policy and Central Banking. This module is written to discuss and explain basic principles and concepts of Monetary Policy and Central Banking in the Philippines. It also covers procedure and some basic legal aspects of Central Banking. It is designed for college students taking up Financial Management course. Monetary Policy and Central Banking is important to study since it is a central part of current economic, business environment and households. With this, many businesses exposed to the risk that can affect the operations and profitability of any business. It is the important task of the Bangko Sentral ng Pilipinas and Monetary Board to formulate a policy to control and manage the current finances of our country. Through module, the students can gain a deeper understanding of the core of Monetary Policy and Central Banking and Monetary Board that is essential in the achievement of the business goals and objectives, not only for the government but also for individuals. This module incorporates worked examples, relevant exercises and case studies that students will see how concept and principle applies in practice and can discuss the various issues raised. Students will also acquire and develop essential knowledge that will improve their competence in all aspects of Financial Management INTENDED LEARNING OUTCOME Upon completion of this course, the students should be able to: Understand the functions, system, standards and roles played by money in the economy and in our daily living Explain the key terms and concepts about money, monetary policy and central banking that will be used throughout this course Discuss the different perspectives of the Central banks authority and its responsibility in today’s economy. Comprehend the different monetary tools and policies utilized and are expected to be used in the future by policymakers and central bankers. Understand the issues of independent Central banking and fiscal policy-making and the strategies they employ.  Chapter 1 The Philippine Financial System What is Financial System? A complex structure and operation Financial system is widespread. its various institution touch the lives of people all over the world The financial system does not only include banks, credit union, pawnshop or usurers, lending investors. World bank, international monetary fund, and the Asian development bank are part of the Philippine financial system of our banking laws and monetary policies Financial System is a network of various institution which generates, circulates and controls money and credit. It provides intermediation between the suppliers and users of credit, It provides loan to poor families, small producers, big businessmen and industrialist, and it stimulates the social and economic development of the country. Elements of Financial System 1. Financial Claims – these comprise the money and the right to receive money under specific circumstances. There are two categories of financial claims, debts and equities. 2. Financial Institution - these are private or government organization whose asset consist primarily of claims or incomes primarily derived from dealing in and or performing services in connection with claims. 3. Financial Markets - these are institutions which expedite transaction in financial claims. Example of financial claims are Philippines Stock Exchange and other organization dealing with money market operations. Financial Market serves as a means of bringing the forces of demand and supply of financial claims 4. Government Agencies - the monetary board is the policy making body of Bangko Sentral ng Pilipinas. The role of the government agencies has a tremendous impact on the financial system. The very important goal of Bangko Sentral is to attain internal and external stability of peso 5. Laws and Policies - the national government regulates and supervises the behavior of the whole economy. Laws and policies have been formulated to ensure the desired levels of investment, employment, production, income and consumption Function of Financial Institution 1. Investigation and credit analysis 2. Matching the supply and demand for funds 3. Provision for liquidity Development of Philippine Financial System Obras Pias the first credit institution established in the Philippines. It means pious works, started by father Juan Fernandez de Leon in 1754, most of obras pias funds were lent out to the traders to finance Galleon Trade, become commercial bank or marine insurance companies when friars take under control, the last out of obras pias came to end in 1820. In 1830, Francisco Rodriguez organized the Rodriquez Bank, This was more of a loan associated than a bank and most clients were American and British Merchants. When the owner died, the bank fund were turned over to the Queen of England. In 1851, the first Philippine bank was established. This was the Banco Español-Filipino de Isabella II. In 1869, the Philippine Trade Expanded thru the opening of Suez Canal. In 1873, Chartered Bank of India, Australia and China set up a Manila Branch 1875, Hong Kong and Shanghai Bank put up it branch in Manila 1883, Hong Kong and Shanghai Bank open branches in Iloilo to finance the sugar industry. 1882, Monte de Piedad was established, it was the first savings bank in 1882. 1883, Banco Peninsula de Ultramirano set up branch in Manila Financial institution during American rule: 1898 when United States acquire the Philippines through Treaty of Paris Payne-Aldrich Act of 1902 – free trade between United States and Philippines 1902, International Banking Corporation of New York set up office in the Country In 1915, the bank was acquired by the National City Bank of New York At Present, this bank is one of the top five banks in the Unites States, it is now called the First National City Bank. 1904, Postal Savings Banks was organized 1906, First Agricultural Bank of the Philippine Government In 1916, assets and liabilities of the bank were transferred to the newly-organized Philippine National Bank (PNB) 1916, Philippine Trust Co. were organized by Catholic Church 1926, Peoples Bank and Trust Co. was established by the Manila-based Americans businessman In 1920s, Chinese banks were formed in the Philippines In 1920, China Banking Corporation In 1926, Bank of China Financial institution during Japanese Occupation: 1942, PNB closed its doors because of the Japanese Imperial Forces. After few months, PNB ordered to reopen for business and it was Japanese Military advisers Southern Development Bank, Japanese Bank, put up branch in the country to perform the role of central bank In 1946, Rehabilitation Finance Corporation was established to provide credit facilities for the rehabilitation of agriculture, commerce and industry and the reconstruction of war-damaged properties. Later on become the Development Bank of the Philippines 1948, creation of Central Bank of the Philippines, however started the operations in 1949. The Structure of Philippine Financial System The Banking Institution The Banking Institution in the Philippines can be categorized as private banking and government banking. The private banking institutions are comprised of commercial banking such as universal banks and ordinary commercial banks; thrift banks like savings and mortgage banks, private development banks, and stock savings and loan association; and the rural banks. The government banking institutions, on the other hand, consist of Philippine National Bank, Development Bank of the Philippines, Land Bank of the Philippines, and the Philippine Amanah Bank. Private Banking Institution 1. Commercial Banking Institutions. The Banks that fall under commercial banking institutions are the ordinary commercial banks or non-expanded commercial banks. These banks continue to account for the bulk of the total resources of banking industry. 2. The Thrift Banks. Thrift banks are primarily engaged in mobilizing the small savings of the people. They provide funds for agriculture and industry at reasonable interest rates. The small producers like farmers, fishermen, craftsmen, and poor consumers can rely on such banks for financing their production and consumptions inputs. The following banks fall under the category of Thrift Banks 3. The Savings and Mortgages Banks. The primary function of a savings and mortgage bank is to receive time deposit of different types and to invest its funds in long term investment. 4. The Savings and Loan Association. Very similar to the savings and mortgage banks are the savings and loans associations nowadays. However, these institutions may either be stock or non-stock corporations. 5. The Private Development Banks. This is quite different from the government institution of the same name. It is a government entity, formerly the Rehabilitation Finance Corporations. 6. The Rural Banks. Rural Banks fulfil the investment function by allowing small farmers to finance their needs through the granting of loans for capital or other uses. Government Banking Institutions 1. The Philippine National Bank. The Philippine National Bank (PNB) operates under the provision of Executive Order No. 80, the 1996 revised charter of PNB. 2. The Development Bank of the Philippines. The Development Bank of the Philippines (DBP) started operating in 1935 as the National Loan and Investment Board. Its first mission was to coordinate and manage trust funds. 3. The Land Bank of the Philippines. The Agrarian Reforms Code created the Land Bank of the Philippines (LBP) to finance the acquisition and distribution of agricultural estates for division and resell these small landholders. 4. The Al-Amanah Islamic Investment Bank of the Philippines. The Al-Amanah Islamic Investment Bank of the Philippines (Islamic Bank) was created under Republic Act No. 6848 for the purpose of promoting and accelerating the socio-economic growth of Mindanao, particularly the provinces of Cotabato, Lanao del Sur, Lanano del Norte, Zamboanga del Sur, Zamboanga del Norte, and Sulu. Non-Bank Financial Institution These are other financial institutions which engage in specific functions. They provide services related to claims, financial information, and advice, manage portfolios of financial assets on behalf of other economic units, buy and sell claims on institution from clients, and assist in finding sources for those economic units seeking loans. These either private or government non-bank financial institution. Private Non-Bank Institutions 1. Investment House/Banks. The term “investment house” is defined to mean as “any enterprise which engages in the underwriting of securities of other corporations. Underwriting is the act or process of guaranteeing the distribution and sale of securities of any kind issued by another corporation. Securities are written evidences of ownership, interest or participation in any enterprise or written evidences of indebtedness of a person or enterprise. 2. Securities Brokers/dealers. Pursuant to the provision of the Revised Securities Act, no broker, dealer, or salesman must engage in business in the Philippines as such broker, dealer, or salesman or sell any securities, including securities exempted under the said law. 3. Building and Loan Association A special type of savings institution. Because of its very nature, however, it falls under this category in view of the fact that is also receives saving from members and lends funds to them. 4. Credit Union A credit union is another type of savings institutions. It also has for its purpose the inculcation of the habit of thrift, frugality and the idea of helping each other. 5. Private Insurance Private insurance companies contribute to the country’s socio-economic developments as well as to the insured. 6. The Pawnshop Pawnshop provides credit to small borrowers who are not qualified to obtain small loans from financial institution. In pawnshop, the cost of borrowing and terms of payment are generally fair. 7. Trust Companies. A trust company is any corporation formed or organized for the purpose of acting as trustee or administering any trust or holding property or on deposit for the use. 8. Non-Stock Savings and Loans Association. A non-stock savings and loans associations is a corporation engaged in the business of accumulating the savings of its member. 9. Financing Companies Financing companies or partnerships, except those regulated by the Bangko Sentral, the Insurance Commissioner, and the Cooperative Administration Office which are primarily organized for the purpose of extending credit facilities to consumer and to industrial, commercial, or agricultural enterprises. 10. Other Non-Bank Financial Institutions. These are financial institution that are unknown to many people. Fund managers, lending investor, and venture capital corporations are among these institution Government Non-Financial Institution 1. The Government Service Insurance System. On May 13 May 1937, the Government Service Insurance System (GSIS) started its operation. Presently, the GSIS administers the following: Life Insurance Fund, Retirement Fund, Health Insurance Fund/Medicine, State Insurance Fund/Employees’ Compensation, General Insurance Fund/Property Insurance, and Barangay Officials’ Life Insurance.  2. The Social Security System On 1 September 1957, the Social Security System (SSS) started its operation. At first SSS granted only death, disability, sickness, and old-age benefits under its social security program for the workers/employees in the private sectors. As its capacity the funding and administrative experience grew, other benefits have added to the program such as hospitalization benefits under the Medicare program, employee’s compensation benefits and maternity benefits Transnational Banks in the Philippines International financial institution which operate in may countries all over the world. Specialized in international finance, and their clients are primary the multinational corporations, governments, big companies and wealthy individuals in the developing countries. Owned by United States, Japan, France and Great Britain. Top 3 US banks operate in the Country Citibank Bank of America Chase Manhattan WB-IMF and ADB Roles in the Philippine Financial system In 1945, World Bank and Asian Development were created. The main objective of World bank was to help reconstruct Western Europe which had been destroyed by World War II, the later on it shifted its goal to funding development projects of the third world country like Philippines. IMF goal has been to ensure an international monetary system that will promote international free trade. ADB started its operation on 1966, the main role of the bank is to help promote the economic and social growth of its developing member countries. Specific examples of WB-IMF policies for the debtor country like Philippines 1. Adoption of floating rate system 2. Devaluation of peso 3. Import liberalization 4. Export promotion 5. Encouraging foreign investment  6. Raising indirect taxes like specific tax on oil products 7. Comprehensive interest rate reform 8. Removal of price controls over essential goods for domestic use 9. Limiting growth of money supply and domestic credit 10. Reducing or eliminating consumption subsidies like rice subsidy 11. Clean election 12. Limiting budget deficit of the national government CHAPTER EXERCISES Direction: Read the given scenario carefully and answer the question comprehensively. Support your answer. 1. Give your own example of what the financial system can do to help the poor. 2. Explain one element of financial system. 3. Give your own views about operations of WB-IMF in the Philippines 4. What is wrong with our financial system?  Chapter 2 Central Banking: Development and Growth What is Inflation? Inflation – the rate of production of goods and services is slower than the rate of increase in money supply then price level rises. Or in common term, inflation occurs in our economy when we lost our purchasing power or the value of the things we buy become higher. Whenever demand for and supply of goods are not equal, market prices change. What is the main goal of central banking? The main goal of central banking is to maintain economic stability, there is therefore a need to regulate properly money supply. Central banks emerged not only to maintain economic stability, but also to help promote economic growth. Nature of Central Banking A central bank is not a profit maximize. It is organized precisely to pursue certain socioeconomic goals which concern national interest or public welfare, such as price stability, full employment and economic growth. Management of the money supply is a vital factor in the whole economy. The objectives of central bank to achieve full employment, price stability and economic growth have not been realized. Central Bank Defined Under the Philippine Law, central bank is defined as the central monetary authority which provides policy direction in the areas of money, credit and banking. It supervises the operation of banks and regulates the activities of non-bank financial intermediaries Main functions of central Bank 1. It acts as a lender of last resort 2. Controller of money supply Banks mobilize the savings of the people, and lend these to businessmen for investment A central bank of any country is interested to promote the expansion of an efficient banking industry in view of its very important role in economic development. To avoid closure of banks, the central bank acts as the lender of last resort. It lends money to distressed banks, including management assistance Origin of Central Banks Bank of England – organized in 1694 as a joint stock company. It extend financial assistance to the distressed government of William II. It was only in 1946 that the Bank of England was nationalized by the British Parliament. The Riksbank of Sweden – it was established in 1656 as a private bank. It was reorganized in 1688 as a State Bank. It was only in 1830 that Riksbank regained its monopoly power to note issue. The Bank of France – created in 1800 mainly from private capital and the rest from the government fund. Founded by Napoleon Bonaparte. The government participated in the operation of the bank through the appointment of the governor and two sub governors Other central banks Bank of Netherlands – founded in 1814 with private capital National Bank of Austria – established in 1817 to restore monetary stability in the country Bank of Norway – established in 1817 with private capital Creation of New Central Banks In the case of United States, it has established its central bank only in 1913 during the time of President Wilson This was followed by South Africa which created its South African reserve bank in 1921. Central Bank of China 1928 National Bank of Iran 1928 Bank of Canada 1935 Reserve Bank of India 1935 Bank of Thailand 1942 State Bank of Pakistan 1948 National Bank of Cuba 1950 Bank of Korea 1950 Union Bank of Burma 1952 Bank of Indonesia 1953  Bank of Israel 1954 Central Bank of Malaysia 1958 The central bank and the economy There is no question that a central bank is very important and powerful institution in an economy Economy – refers to the proper allocations and efficient use of source resources to satisfy human wants A central bank can direct flow of money and credit into the various sectors of the economy. It can also improve the social and economic conditions of the poor by making credit facilities accessible to them Bangko Sentral ng Pilipinas Bangko Sentral ng Pilipinas is the central monetary authority based on R.A. 7653 or known as the New Central Bank Act. It has a policy making body which provides direction in the field of money, credit and banking. The Bangko Sentral supervises the operation of the banking institutions and regulated the activities of the non bank financial institutions. A brief history of BSP Miguel Cuaderno, the first governor of the Central Bank who developed the concept of central bank in 1933 It was only in 1946 that a formal preparation for the organization of a central bank stated upon instruction of President Manual Roxas Central Bank of Guatemala – chose as the model of our central bank in view of the similar social and economic conditions prevailing in said country with our own A central Bank council was formed in August 1947 to review the report of the Commission and to prepare the necessary legislation for its implementation President Roxas submitted to congress a bill establishing the Central Bank if the Philippines. This bill was to become Republic Act No. 265, also known as the Central Bank Act The Charter of Central Bank was signed into law on June 15, 1948 by President Elpidio Quirino. The Philippine Central Bank was inaugurated and formally opened on January 3, 1949 with Miguel Cuaderno as its Governor  Act no. 52, passed by the First Philippine Commission, placed all banks under the Bureau of Treasury The Insular Treasurer was authorized to supervise and examine banks and banking activities February 1929, the Bureau of Banking took over the supervision of banks Objectives and Responsibilities of the CBP 1. The Primary task of the old Central bank of the Philippines is to administer the monetary, banking and credit system in the country 2. In 1949, when the central bank opened, there were only 11 head offices and 75 branches of commercial banks in operation 3. It was during the early 1970s that non-bank financial institutions, especially investment houses and finance companies cropped up Original Objectives 1. Maintenance of Monetary stability in the Philippines 2. Preservation of the international value of the peso and its convertibility into other freely convertible currencies 3. Promotion of a raising level of production, employment and real income in the Philippines. Monetary Stability – means price stability. If there are wide fluctuations in price levels, there is no price stability or monetary stability Real Income – refers to the number of goods our income can buy. Amended Objectives A joint IMF-CBP banking survey commission was established in 1971 to formulate strategies on how to ensure the soundness and healthy growth of the banking system 1. To maintain internal and external monetary stability in the Philippines, and to preserve the international value of the peso into other freely convertible currencies 2. To foster monetary, credit and exchange conditions conducive to a balance and sustainable growth of the economy. CHAPTER EXERCISES Direction: Read the given scenario carefully and answer the question comprehensively. Support your answer. 1. Why money is important in the economy? 2. What is wrong if there is too much money in circulation? 3. What is the difference between a central bank and a commercial bank? 4. What do you mean by central monetary authority?  Chapter 3 Central Monetary Authority President Fidel Ramos has envisioned the Philippines – by the year 2000 – to attain its newly industrialized country – status. By the that year, the president believes that most Filipinos will have decent and dignified existence. The Ramos government has formulated twin goals; global excellence and people empowerment. In this connection, the following growth strategies have been adopted; Commitment to a planned free market economy Industrializing from a base of agricultural productivity Encouraging a high saving rate Developing an educated work force Fostering export industries Building solid structure Bangko Sentral and the Philippines 2000 The new Central Bank act declares as a policy 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 in the areas of money, credit and banking. The Bangko Sentral has been capitalized by P50Billion and expected to perform efficiently its responsibility and attain its primary objective which is to maintain price stability conducive to a balance and sustainable growth of the economy. It shall also promote and maintain monetary stability and convertibility of peso. The fuel of economic growth The emphasis of the government is the major role of the private sector as the engine of economic growth. Such people empowerment is one of the goals in achieving the vision of the Philippines 2000. Evidently, money becomes the fuel of the economic growth. Monetary Board The power and function of Bangko Sentral shall be exercised by the Monetary Board. These are seven members of the Monetary Board who are appointed by the President of the Philippines for a term of six years. The members are the Governor of the Bangko Sentral who is the Chairman of the Monetary Board and a member of Cabinet and five form private sector. No member of the Monetary Board may be reappointed more than twice. Power of Monetary Board 1. Issue rules and regulation for the effective discharge of the responsibilities and exercise of the power vested upon the Monetary Board and Bangko Sentral 2. Direct the Management operations, administration of the Bangko Sentral 3. Established a human resource management system which shall govern the selection, hiring appointment, transfer, promotion or dismissal of all personnel 4. Adopt an annual budget for the effective administration and operations of the Bangko Sentral in accordance with applicable laws and regulations Power and Duties of Governor Prepare the agenda for meetings of the Monetary board and to submit for the consideration of the board the policies and measure which he believes to be necessary to carry out the purpose and provisions of the New Central Bank Act Execute and administer the policies and measures approved by the Monetary board Direct and supervise the operations and internal administration of the Bangko Sentral. The governor may delegate certain of his administrative responsibilities to offer or may assign member of the Monetary board without additional remuneration or allowance Appoint and fix the remunerations and other emoluments of the personnel below and rank of a department head in accordance with the position and compensation plans approved by the monetary board, and also to impose disciplinary measures on the personnel of Bangko Sentral Render opinions, decision or rulings, which shall be final and executory until reserved or modified by the Monetary Board, on matters of laws pertaining to institutions supervised by the Bangko Sentral and laws pertaining to quasi-banks as well as regulations, policies or instructors issued by the Monetary Board Exercise such other powers as may be vested in him by the Monetary board Transparency of the Bangko Sentral The Monetary board shall publish and submit the following reports to the president and congress Quarterly reports on the analysis of economic and financial developments, including the conditions of net international reserves and monetary aggregates Annual report on the proceeding year’s budget and profit and loss statement of the Bangko Sentral showing on reasonable detail the result of its operations Semestral report on the review of the state of the financial system As soon as practicable, a report on the abnormal movements in monetary aggregates and the general price level and the level and the remedial measures in the response to each abnormal movements Annual report on the condition of the Bangko Sentral including a review of the policies and measures adopted by the monetary board during the past year and an analysis of the economic and financial circumstances which gave rise to the said policies and measures Domestic Monetary Stability Monetary Stability means price stability. When the rate of production of the money supply is greater that the rate if production of goods and services price level increases. This means inflation. Printing of Money by a central bank creates inflation. The New central bank acts states whenever abnormal movements in the monetary aggregates, in credit or in prices endanger the stability of Philippine economy or other important sectors, the Monetary board shall: Take remedial measure that are appropriate and within powers granted to the monetary board and bangko sentral, and Submit to the president of the Philippines and congress and make public, a detailed report which shall include, as a minimum, a description and analysis of the following; 1. Causes of the rise and fall of the money aggregates credit or prices 2. The extent to which the changes in the monetary aggregates, credit or prices have been reflected in changes in the level of domestic output, employment, wages and economic activity in general, and significance of such changes; and  3. the measures of which the Monetary board has taken and the other monetary, fiscal or administrative measures which it recommends to be adopted International Monetary Stability International Monetary Stability simply means stability of the foreign exchange rate of the PESO against foreign currencies. Whenever, there is a great demand for the dollars or other foreign currencies, and the Bangko Sentral has no adequate supply such foreign exchange rates are basically determined by the law of supply and demand Composition of the international reserves includes gold and assets in foreign currencies in the form of: 1. Documentation and instruments customarily employed for the international transfer of fund 2. Demand and time deposits in central banks, treasuries and commercial banks abroad 3. Foreign government securities 4. Foreign notes and coins CB recognition To enhance the efficiency of the new Bangko Sentral, and Central bank has been restructured. Redundant positions were abolished Six operational sectors were merged into three Several operating departments were merged Hierarchical levels of authority across all departments were reduce from 5 to 3 A greater number of the organizational functions been computerized. CHAPTER EXERCISES Direction: Read the given scenario carefully and answer the question comprehensively. Support your answer. 1. What is a central monetary Authority? Why is it considered more effective than the previous central bank? 2. Explain domestic and international monetary stability. How do you relate such stability to economic development? 3. Give me one amendment in the R.A 7653 to R.A 11211. Then why it is amended?  Chapter 4 Function and Operation of the Bangko Sentral Characteristic of Central Banks The profit motive is only secondary in the operations of the central banks The operations of central banks are more extensively controlled by government It is undesirable for the central banks to deal directly with the public Functions of the central bank It is a bank of issue It is the government’s banker, agent and adviser It is the custodian of cash reserves of banks It is the custodian of the nations reserves of international currency It is a bank of rediscount and lender of last resort It is a bank of central clearance and settlement It controls credit Monetary Tools Open market operation – involve the buy and sale of government securities Reserve requirements – control volume of money by the operations of the banking system Interest rate policy Rediscounting Swap facility Moral suasion Other credit control instruments used by Bangko Sentral in order to support the monetary stability: Margin requirements against letters of credit Security against bank loan  Portfolio ceilings Minimum capital ratios Activities of the Central Bank To ensure the steady growth of the financial system Keep the external debt at a manageable level Maintain a stable foreign exchange position Activities include: Bank supervision/pawnshop regulation External debt regulation Money market involvement Foreign exchange regulations Export related measures Worker’s remittances Commodity classification The Bangko Sentral and Industrial Development Rediscounting facility Industrial guarantee and loan fund Apex development finance The Bangko Sentral Coordinates with International Institutions South East Asian Central banks South East Asia, New Zealand, and Australia Central banks Association of Southeast Asian Nations Asian Development Bank International Monetary Fund  World Bank Credit Operations of the Bangko Sentral Normal Credit operation a) Commercial credits b) Product credits c) Advances Special Credit Operations a) Loans to long-term lending institutions b) Loans to the Development Bank of the Philippines c) Loans to non bank Financial intermediaries d) Emergency credit operations e) Credit operations with the government September 7, 1978 – the security plant complex of the old central bank started its operations Composed of: Security printing plant Mint Gold Refinery The Security printing plant produces banknotes and securities. Annual capacity consist of : 600 million pieces of banknotes 4 billion pieces of cigarette strip stamps and wine labels 120 million checks and other security documents 1.5 million passports Mint and Gold Refinery can produce 600,000 troy ounces of refined gold and 450,000 troy ounces of refined silver acceptable in the international markets. It can also produce 850 million coins a year. Transaction Modules Gold Reserves Location Swap Exchange Type Fixed rate Gold Deposit Gold-Dollar Linked Deposit Silver Reserves Sale if Silver City bars Fixed Rate Silver Deposit Shortcomings of CB’s in Less Developed Counties It is not uncommon for not a few central banks, particularly in the less developed countries, that their main concern is internal monetary stability. They are much engrossed with the ways of regulating money supply in order to avoid inflation. Thus, in more ways than one, they overlook the potentials or opportunities for economic development. Central banks in the less developed countries believe that they must play a leading role in financial development such as: (Drake, 1980) 1. Guiding the activity of foreign banks towards local needs 2. Fostering the establishment of domestic banks and specialized financial institutions 3. Supervising the operations of all financial institutions so that local confidence may be maintained, and monetization and intermediation thus encouraged 4. Promoting developing of money and securities markets and the spread of financial technology, and endeavouring to influence the money supply and manage the exchange rate so as to avoid inflation There are several reason for such shortcomings of monetary tools such as the absence of well- developed bond and securities market. And lastly, in the Philippines money lenders are dominant in the rural areas, factories, offices and markets. Evidently the monetary tools of Bangko Sentral do not touch informal financial institutions. CHAPTER EXERCISES Direction: Read the given scenario carefully and answer the question comprehensively. Support your answer. 1. Why the central bank have the sole power to issue notes? 2. What do you mean by the Bangko Sentral is an agent of the government? 3. Explain the central bank shortcoming in the Less Developed Countries like Philippines.  Chapter 5 Regulation and Supervision of Financial Institutions The Business of a Financial Institution like a bank is imbued with Public Trust and Public interest. The bangko sentral sees to it that operations of financial institutions are consistent with the objectives of monetary policies such as price stability, full employment and economic growth. Bangko Sentral supervises the following Banking Institution Universal Banks/Expanded Commercial Banks Ordinary commercial banks Savings and mortgage banks Private development banks Saving and loan associations (stock) Rural banks Government banks, such as PNB, DPB, LBP and PAB Pawnshops Investment houses Investment Companies Financing Companies Securities dealer and brokers Lending investors Building and Loan Association Fund managers for retirement, provident and pension funds Saving and loan association (non-stock) Supervision and Regulation Distinguished Supervision includes not only the issuance of rules and regulations but also the overseeing of the operations of financial institutions. Supervision is broader in scope than regulation because the former seeks to look into the details of operations, activities and performance of a particular as they affect both private and private interest Regulation refers to the issuance of rules and conduct or the establishment of modes or standards of operation for uniform application to all financial institutions or functions covered. Regulation is basically undertaken through review and analysis of reports submitted by a financial institution to a government agency concerned Types of Examination 1. General examination – this undertaken once a year 2. Special or Interim Examination – this is conducted as often as necessary, it includes a review of a special account or groups of account such as loans or deposits 3. Special Investigation – Although this is not an examination. It’s procedure sometimes involves some steps of what are being done in regular and special examinations. Said investigation is conducted when a complaint is receive by the bangko sentral from a borrower, stockholder, depositor or an employee or even from anybody regarding the operation of financial institution Purpose of Supervision and Regulation To ensure full compliance with laws, rules and regulations affecting the operations and activities of financial institutions To ensure that the financial institutions being supervised and regulated are operating on a sound financial basis (that is, they are solvent and stable), so that their stockholders are assured of a fair return on their capital investment To act as guardian of depositors and money market investors in order to ensure that they get not only the interest payments but also their deposits and placements. To protect the interest of the investments of the government To protect the interest of other creditors of financial institutions To ensure the stability, solvency and safety of our financial system towards the economic development of urban and rural areas. Benefits of Bank Controls Prevention of over-expansion or under-expansion of money and credit through a system wide monopoly or through excessive competition Elimination of monopoly  Protection of depositors against the consequences of bank failures Supervision and Examinations of banking Institutions Examining the books, documents and records of banking institution operating in the Philippines, including all government credit institutions (together with their subsidiaries and affiliates), and non-bank financial intermediaries including their subsidiaries and affiliates performing quasi banking functions if special examination is needed as determined by the monetary board. The department heads and examinees of the supervising and/or examining departments are authorized to administer oaths to any director, officer or employee of the banking institution under their respective supervision or subject to their examination Compel the presentation of all book, documents, papers or records necessary to ascertain as well as the book and records of person and entities in connection with the operations, activities or transaction of the concerned institution No restraining order or injunction is to be issued by the court enjoining the Bangko Sentral from examining any institution subject to the supervision and/or examination by the Bangko Sentral, unless there is a convincing proof that the action of the Bangko Sentral is arbitrary and made in bad faith Department heads and examiners are authorized by the Monetary Board to examine, inquire or look into all deposits of whatever nature with the banking institutions in the Philippines, including investment in debt instruments issued by the national government, its political subdivisions and its instrumentalities, after being satisfied that there is reasonable ground to believe that a bank fraud or serious irregularity has been committed and that it is necessary to look into the deposit to established such fraud or irregularity. Who is Conservator? A person who manage banking institution which cannot adequately protect the interest of depositors and creditors. Cannot be connected to the Bangko Sentral and, Competent in bank operation and management. Powers of conservator Take charge of the assets, liabilities and management of depressed banking institution collect all monies and debts due said bank and exercise all powers necessary to preserve the assets of the bank Reorganize the management of the bank and restore its viability  Overrule or revoke the actions of the previous management and board of directors of the bank, provision of law to the contrary not with standing, and such other powers granted by the Monetary Board which are deemed necessary. Insolvency Proceedings Who is Receiver? Any person of recognized competence in banking may be designated as receiver. He immediately take charge of the assets and liabilities of the bank under receivership. He collects all existing debts. He gathers all the asset and pay corresponding taxes due to the government and obligations to creditors of record. The most important function of a receiver is that he preserves the asset as much as possible by filing suits and foreclosing mortgages in the name of the bank or non-bank financial intermediary performing quasi-banking functions. Designation of a Liquidator Monetary board designates an official of the Bangko Sentral as liquidator. Liquidator speedily converts the assets of the bank or non-banking financial intermediary with quasi-banking functions to money or sell, assign or dispose them to creditors and other parties for the purpose of paying the debts of the bank concerned. The actions of the Monetary Board are final and executory. However, these can be set aside by the court, only if, there is convincing proof that such actions have been plainly arbitrary and made in the bad faith. A bank is said to be insolvent if its realizable assets as determined by the Bangko Sentral are sufficient to meet its liabilities CHAPTER EXERCISES Direction: Read the given scenario carefully and answer the question comprehensively. Support your answer. 1. Cite examples of financial institution under the supervision of the Bangko Sentral 2. What is the difference between supervision and regulation? 3. What are the major benefits of bank controls?  Chapter 6 The Role of IMF in Central Banking International Monetary Fund together with the International Bank for Reconstruction and Development (IBRD), now known as World Bank. It was a creation of the Bretton Woods Conference in 1944 at New Hampshire, USA. June 25, 1946, the twin organization (WB-IMF) opened their doors for business. Philippines is one of the original Members. The Principal task of the IMF is to extend short-term loan to countries with balance of payments problems. For many years poor countries have been experiencing deficit balance of payments. This means their outflow of foreign change is greater than inflow of their financial resources. A country without foreign exchange (like US Dollar) cannot import materials for its factories like what happen in the Philippines in 1984. Organizational Structure Board of Governors – the highest authority of the International Monetary Fund Each Member country is represented by a Governor and an Alternate Governor In most cases, IMF Governor are secretaries of finance or central bank governors in their countries The Board of Governors has delegated many of its powers to the Executive Board which is responsible for conducting the business of the IMF The Governor usually meet once a year to decide on important issues such as: Admission of new members Adjustment of quotas Election of directors And other vital matters Executive board is in permanent session at the Fund headquarters in Washington. It regularly deals with a wide variety of administrative and policy matters Issues annual reports to the board of governors  Conduct discussions to complete the process of consultation with members From time to time produces comprehensive studies on crucial issues if particular relevance to the international financial aspects of the IMF members There are now 22 Executive Directors 7 appointed by the biggest stockholders of IMF namely the, United States of America United Kingdom Federal Republic of Germany France Japan China Saudi Arabia Each of the major stockholders can appoint 1 Executive Director The Managing Director is the Chief of the IMF staff and Chairman of the Executive board. Next to him is the Deputy Managing Director. The United States has the largest shares of stock in both the WB and IMF. It controls about 20% of the capital stocks of said international financial institutions. Voting power of each member country depends on its number of shares of stock. The Philippines has 0.49% of the total quota share, and its voting power is 0.5% of votes. IMF Objectives 1. To promote international cooperation through a permanent institution which provides the machinery for consultation and collaboration regarding international monetary problems 2. To facilitate the expansion and balanced growth of international trade, and to contribute to the promotion of high levels of sustained employment, production and income among the member countries 3. To promote exchange stability, to maintain orderly exchange arrangements among member countries, and to avoid competitive exchange depreciation  4. To assist in the establishment of a multilateral system of payments on current transactions between member countries, and elimination of foreign exchange restrictions which hamper the growth of international trade 5. To provide confidence to member countries with balance of payments problems by extending various credit facilities to them 6. To shorten the duration and reduce the degree of disequilibrium in the international balance of payments of member countries Quotas of IMF Members Every IMF members is required to subscribed to the IMF and amount equal to its quota It has to pay in gold or US dollar the 25% of its quota The remainder is paid in the members own currency It is Philippine PESO in case of the Philippines. The quota of a member country is based on its economic strength Quotas of member countries which at present is approximately SDR 89.2billion are closely related to: Their subscription to the fund Their drawing rights on the fund Their voting power Their share of allocation of SDR’s Normal Facilities of IMF 1. Ordinary drawing rights 2. Stand by arrangement 3. Special drawing rights IMF Special Facilities 1. Extended fund facility 2. Compensatory financing facility 3. Buffer stock financing facility  4. Enlarged access policy IMF Conditionality The Financial resources of the IMF are revolving pool of funds. A member country who applies for the use of such resources is generally required to carryout an economic policy program aimed attaining a viable balance of payment position over an appropriate period of time. This requirement is known as CONDITIONALITY. Viable payment position means a current account deficit that can be sustained by capital inflows on terms compatible with the development prospects of the country. Basis of Conditionality The role of IMF is to help alleviate the balance of payments difficulties of member countries. Conditionality is in essential element in such role. It seeks to ensure that the member policies are adequate to achieve a viable balance if payments position over a reasonable period of time. The fundamental questions of whether adjustment is required depends on the nature of the balance of payments problems. If the imbalance is temporary and self-reversing in a reasonable period of time, adequate IMF financing is all that is required. LDC’s demand for Growth and Liquidity Less developed countries (LDC) demand top priority for growth and liquidity. During the WB- IMF conference in Seoul, South Korea in 1985, the less developed countries opposed the IMF conditionally being imposed on the less developed countries. The requirement of IMF on the heavily indebted countries is for them to sustain a economic stability. Dr. Dragoslave Avramovic, a distinguished economist from Yugoslavia said that without economic growth and the means to secure it, there is no viable solution to the debt crisis.. Pointed out that IMF should make development rather than austerity a major objective in working out the conditions on which it assists the LDC facing balance of payments difficulties The demand of the less developed countries are : 1. Economic growth 2. Liquidity 3. Soft loans (low interest rates) IMF is prepared to provide adequate financial support to counties seeking additional credit that are willing to adopt the usual IMF appropriate policies such as : 1. Devaluation 2. Free trade 3. Expansion of foreign investment 4. Increase of taxes 5. Political reforms New International Monetary System The less developed countries have clamoured for a new international monetary system. A new international monetary system was formally make at the North-South conference on the International Monetary system and the New International Order held in Tanzania, Africa in 1980. The present IMS (also known as the Bretton Woods Monetary System) favors only the few Industrial countries like: 1. United States 2. Japan 3. France 4. Great Britain 5. West Germany and their multi-national corporations The main objective of the World Bank and the Fund is the expansion of international trade and foreign investments without restrictions Objectives of New International Monetary System 1. It must be capable of a) Achieving monetary stability b) Restoring acceptable levels of employment and sustainable growth c) Checking the present strong inflationary tendencies in the world economy 2. It must be supportive of a global development, especially for the third world countries where most of the world’s poor lives Characteristics of New International Monetary System The principal characteristics of a new international monetary system must be: 1. Democratic Management and control 2. Universality 3. Establishment of an international money 4. Organization of new international monetary authority World Central Bank It provides a uniform and universally acceptable currency with a stable value. It exercises systematic control of the total supply of currency reserves. It regulates balance of payments portion of member countries. British economist John Meynard Keynes, one of the founders of the World Bank and the IMF proposed the creation of a world central bank during 1940s. IMF Criticized President Alan Garcia of Peru stated that the IMF is an “imperialist agency that hinders Third World development”. He said that IMF delegates will not be allowed in Peru and repeated that the nation will not listen to IMF economic recommendations. Peru had $14million foreign debt, and it could not pay the $70million in overdue interest. President Garcia intended only to use 10% of his country export earnings for its foreign debt payment. But IMF did not agree and warned that it could declare Peru ineligible for new IMF loans, including those coming from World Bank. Our country has also about $26billion foreign debt left by the Marcos regime. The borrower is the Lender’s Slave IMF and WB are neither civic organization not engaged in Philanthropy. The biggest stockholders of WB and IMF think for their own business interest, they merely follow the law of human rights. To avoid such problems, they should minimize their foreign borrowings. The Policy of IMF and WB is: To impose higher interest rate More rigid measures in nations with large foreign debts In case of Aquino government, it intends more on local capital and investment for the development of the country. CHAPTER EXERCISES Direction: Read the given scenario carefully and answer the question comprehensively. Support your answer. 1. Why borrower’s countries are slave of the lenders? Explain. 2. Give me your own reaction to IMF conditionality towards Third World member countries. 3. Explain briefly the organizational set-up of IMF.  Chapter 7 Balance of Payments Adjustment in the Third World Balances of International trade Why do countries trade? Those which have practiced trade have reaped the fruit of abundance and prosperity for their national economies and for their own people. In fact, countries with the widest participation in trade are the most developed countries. These are the present industrial countries like the United States, Great Britain, France, Japan and Germany. General bases of international trade: Distribution of economic resources Technological efficiency International Trade Trade means exchange of goods and services. International trade refers to the exchange of goods and services between one country and other countries Poor countries exchange their agricultural crops and raw materials, with the machines and industrial equipment of the rich countries Feudalism was the only form of economy which subsisted on primitive agriculture Mercantilism is a politico-economic doctrine that believes that the power and glory of a country emanates from the acquisition of more gold and silver through a favorabe foreign trade Galleon trade in the Philippines is one of the example of mercantilism during the Spanish time Bases of International Trade Supposing all countries have exactly the same economic resources like land, labor and capital, and they produce their goods and services with the same efficiency, quality and price. It seems there is no more need for international trade. However, even if such assumption do prevail, it is still better for every country to specialize in the creation of goods and services. The rich countries have better technologies that the poor countries is also responsible in their variant economic activities. Here are the general bases of international trade: 1. Distribution of economic resources 2. Technological efficiency Advantages of International Trade Economic growth for any country is inconceivable Stimulus product specialization due to the very keen competition in the world markets Improves the standard of living of the people Helps in accelerating the economic development of underdeveloped countries Classical Theory of Comparative Advantage Adam Smith said that it is cheaper to buy a product than to produce it, then do not produce it. David Ricardo refined the theory of comparative advantage. This theory states that a “country should export those goods in which it has the greatest advantage and import those goods in which it has the greatest disadvantage” Barriers of Free Trade Tariffs and Quotas Only encourage economic inefficiency, restrict commerce, and reduce the general standard of living. The wealth of nations published in 1776. Free trade. Subsidies of exports, non-tariff barriers to import, guaranteed credits, as well as the manipulation of exchange rates become the order of the day. Balance of Payment Large foreign debt – example of loans from other countries Presence of many multi-national corporations in our country – example of investment from other countries Definition of Terms Balance of Payments – annual accounting statement of all financial transaction of a country with the rest of the world. These include transaction of individuals, businessmen and government agencies of one country with the individuals, businessmen and government of other countries. It appears like a profit and loss statement of business corporation Balance of Trade – situation where the value of the exports of a country is equal to the value of its imports. These pertains only to good. Services are excluded. Visible items- refer to goods in the balance of payments Invisible items – pertain to services in the balance of payments Surplus balance of payments – situation where the receipts (income) are greater than the payment (expenses) Deficit balance of payments – situation where the receipts are lesser than the payments Credits – these are the receipts of individual’s organization or government coming from other countries. Samples are salaries of oversees workers, IMF loans, foreign donations, US bases rentals, export earnings, expenses of Japanese tourist in the country, etc. Debits – these are the payments of individuals, organizations or government of a country to other countries. In short, these are outflows of resources from a country. Samples are, import payments, travel abroad, repayment of World bank loans, foreign studies, donations (cash, books or equipment ) to Africa, investment in New York, etc. Component of balance of payments Current account – this includes exports and imports of goods and services. Sample of goods are rice, sugar, corn, car, tractor and oil. In case of services, these are tourism, education, insurance, banking and transportation Capital Account – it is a record of all transactions relating to private investment, grants and loans with other countries Official Monetary reserves / cash account – these are the assets of the central bank in the form of gold reserves, international currency reserves (like US Dollars, British pound, German mark, Swiss franc, French franc, Japanese yen and other acceptable international currencies) and the Special Drawing Rights (SDRs) Cases of balance of payments deficits Structural or real causes – the traditional exports of the less developed countries are predominantly primary products, such as tea, coffee, sugar and copra. This means whether there is a great increase or decrease in the prices of such products, the quality demanded does not change much With low demand and with low prices of primary products in the world markets – which are actually controlled by the industrial countries – the export earnings of the less developed countries are also low. On the other hand, the less developed countries import finished or industrial products from very few highly industrial countries. Sample for these are machines, chemicals and other industrial raw materials, are very vial to the less developed countries. Monetary causes – improper monetary policies can create balance of payments problems for a country. The infusion of more money supply into the economy increases the demand for goods and services. This produces inflation because the supply of goods and services has not increase as much as the increase in the money supply. This is called by the economist by demand-pulled inflations Solutions to balance of payments deficits Adjustment – equalize receipts and payments On the part of the central bank, it can execute any of the following policy measures: 1. Increase cash margins 2. Total ban on the importation of luxuries and non-essential goods or goods which are prejudicial to the interest of the Philippine economy 3. Limit dollar allocations 4. Impose higher exchange rate for the importation of such goods Appropriate balance of payments policy A good policy for improving the balance of payments position of a less developed country should not only be directed in increasing receipts or decreasing payments. It should above all, consider the welfare of the masses, particularly the poorest of the poor. If improving the balance of payments position of a poor country means enriching only a few members of a society, then such policy is meaningless. In fact, it only widens the gap between the many poor and the few rich. CHAPTER EXERCISES Direction: Read the given scenario carefully and answer the question comprehensively. Support your answer. 1. Why most of the counties of the world are poor? Explain. 2. Cite examples and explain how the poor are affected by the devaluation of peso. 3. What are your own proposals of improving our own balance of payments position?  Chapter 8 Exchange Rate Policies of the LDCs The money of a country is its symbol and identity, just like its flag. Currencies serve not only as media of exchange but also as unit of account. This is, money is not only used as means of buying goods and services which are expressed in the form of prices. Obviously, without money it is difficult to determine the accurate value of a product. But if goods and services are to be traded in the international markets, an international payments system is needed. Such system links together monies of various countries. This is the exchange rate which is the price of one currency express in terms of another currency. Exchange rate are determined by market forces of demand and supply, unless Central Bank directly interferes in manipulating such forces. The choice of an appropriate exchange rate policy by the Central Bank depends on the economic conditions of our country. Exchange Rates Exchange rate is the price of the currency expressed in terms of another currency. Foreign Exchange Rate – the price of a foreign money relative to the local money Floating or flexible exchange rate system – the price of the dollar relative to the peso is determined by the free market forces of demand and supply - once the price of the dollar increases the dollar is appreciated and the peso depreciated Depreciation is also known as currency devaluation Devaluation – the increase of price of gold relative to a currency Exchange rate can be overvalued or undervalued. The value of a U.S Dollar against out peso is determined by the demand for and supply of dollars. Granting that the real market value of a dollar is P25, if the official rate of the Central Bank is P20, then our peso is overvalued. In case the official exchange is P30, then our peso is undervalued. Overvalued because it requires only P20 and not P25 to buy a dollar. Undervalued because it requires P30 and not P25 to buy a dollar. On the other hand, an overvalued currency discourages exports and encourage imports which leads to balance of payments deficit. Determinants of exchange rate A foreign exchange rate is a price. In the case of the U.S dollar, it is the price of a dollar in terms of peso. Without government restrictions or regulations on the buy and sell of dollars, the price of the dollar is determined by:  1. Relative income changes – an increase in the purchasing power of the Filipinos tends to increase imports of US products and services. The rise and fall in the exchange rates is due to the law of supply and demand; whenever demand is greater than supply, price increases, and if its supply which is greater than demand, then price decreases. Anything which is abundant and there is little demand for it is very cheap. This applies to foreign exchange. 2. Relative price changes – in case prices of goods and services are much higher in the Philippines than in the United States, Filipinos are inclined to buy from the United States because of lower prices. This results to greater demand for US dollars, and so the exchange rate of the Dollar increases. On the other hand, the value of the peso falls. If it is the Philippines which has the cheaper prices of goods and services, then there is an increase in the demand for Philippines goods and services. 3. Relative interest rate – supposing interest rates are higher in the Philippines than in United States. These reduce Filipino investments in the United States while Americans increase their investment in the Philippines. 4. Other factors – without import restrictions and foreign exchange controls, there are other factors which tend to increase our demand for goods and services, these are: Colonial mentality State of our economic development Exchange Rate Policies Most less developed countries have been experiencing balance of payments difficulties. Even some rich countries have suffered such aforementioned problems. In case of United States, it has undergone several years of balance of payment due to its huge military expenditures and financial assistance to other countries. In case of Japan, it has enjoyed tremendous surpluses in tis balance of payments. This has triggered several complaints from the United States and other trading nations because of their balance of trade deficits with Japan. A country with a persistent balance of payments deficit could maintain the official rate of exchange by using its international reserves (gold, U.S dollars, SDRs or British pound). If these are not enough, it has to borrow from the World Bank, International Monetary Fund, rich countries and private international financial institutions. In addition, it has to restrict imports by means of tariffs, quotas and dollar allocations. Deficit countries may eliminate its balance of payments problems by adopting any of the following exchange rate policies: 1. Pegged Exchange Rate – the price of a foreign currency like US Dollar is fixed by the monetary authority or central bank  2. Free floating or flexible exchange rate – the price of a foreign currency such as US dollar is determined by the free interplay between the forces of a demand supply 3. Managed Floating Exchange Rate – the exchange rate are also the results of the demand and supply forces. The Bangko Sentral intervenes, however, in the demand and supply of foreign currencies to smooth out disorderly or erratic fluctuations of exchange rates. There are two types which are: Clean Float – monetary authorities of a country interfere in the foreign exchange market only for the purpose of maintaining orderly trading conditions Dirty float – monetary authorities intervene to achieve objectives other than the maintenance of orderly trading conditions Foreign Exchange Market Made up of commercial banks operating in the country. all are members of the Bankers Association of the Philippines Section 80 of the Central Bank – requires the bank to report the volume and composition of their purchases and sales of gold and foreign exchange each day and must furnish such additional information with reference to the movement in their accounts in foreign currencies Black Market Their purchases and sales of US Dollar do not pass through the official banking channels. The supply of black-market dollars is made up largely of inward remittances of foreign exchange leakages arising from inaccurate valuation of foreign trade industries. The black market for US dollars is a fairly market. This is because the general public, such as the importers, speculators, smugglers or ordinary individuals who need a few more dollars for travel purposes beyond what the Bangko Sentral ng Pilipinas will sell them, will have to get their dollars some place. And that inevitably is the black market. The Binondo Central Bank Presidential anti Dollar Salting Task Force formed the Task Force Luntian popularly known as the Binondo Central Bank. With the organization of the Task Force Luntian, the difference between the official exchange rate and the black market rate gradually narrowed. Organization and Operations Under a political and economic uncertainties, the black market rate is much higher than the official exchange rate. Demand for dollars from the general public exceeds the ability of official sources to satisfy such demand. In short, demand is greater that supply which makes the price of the dollar higher relative to the peso. During the such periods, the gap between the official exchange rate the black market rate widens. The government developed a scheme to deal effectively with the black marketers. Hence, the Binondo central Bank was organized with the full knowledge and authority of former president Marcos. The IMF was also informed about the objectives and operations of the Binondo Central bank. Vital facts about organization and operation of the aforementioned bank in Binondo as presented by Roberto Ongpin: 1. The operation task force Luntian was organized in early 1984 by former Minister Roberto Ongpin upon the instruction of President Marcos 2. Initially, the biggest and best known Chinese black marketeers have been rounded up by the National Intelligence and Security Authority (NISA) 3. Originally, there were 8 Chinese participants 4. Each participant was authorized to have his own network of buying and selling over the country 5. The dollar were purchase by their buying outlets from the public, tourist, families off oversees workers and US military personnel from Clark and Subic 6. Security of the operation was provided by the NISA, a member of the Task force 7. Under NISA security, the dollars were airshipped daily to HongKong through PAL commercial flights or the Air Mindanao Lear Jet 8. Selling operational were considered in the Yuchengco Building in Binondo 9. Excess dollars which were not sold to the importers and the general public were sold to the central bank through PASAR 10. Chinese participants were permitted tot make a spread of 20 centavos per dollar 11. The government did not engage in actual buying and selling operations which undertaken entirely by the Chinese participant The Choice of Exchange Rate Policy Guidelines for evaluating the sustainability of a pegged exchange rate policy and the floating rate policy 1. The source of disturbance 2. The degree of openness 3. Product diversification 4. The relative rate of inflation 5. The level of international reserves 6. Trade elasticities Fear of LDCs about Floating Rates the pegged exchange rate system was established by the Bretton Woods Conference in 1944. In view of the growing inflation with increasing divergence in inflation rates among industrial countries, the pegged exchange rate system was abandoned. The floating exchange rates system was adopted in early 1970s. Negative attitudes towards the floating rate 1. Business uncertainties 2. Additional fluctuations in commodity prices Surrender to IMF Policy The Central Bank governor had a big problem of bridging the gap between the lack of dollars in the face of maturing foreign debts and the requirements of essential imports. The last option was to adopt floating exchange rate policy as a condition for the release of IMF loan. The result of adopting IMF policy: 1. Extension of maturing loans 2. Consortium of US banks granted $120million loans to the country 3. Japan gave the Philippines $50 Million standby credit Serious implications of the adoption of the floating rate policy by the Central bank in compliance with IMF condition 1. Cash push inflation 2. Automatic increase in foreign debts 3. Decline in investment Alternative Policy Proposals 1. There should be foreign exchange control 2. Imports had to be selective depending on the needs of the company 3. Tight credit policy should be enforced to curb inflation 4. Sound fiscal policies, such as reasonable government expenditures, efficient tax administration and balanced budget should complement the monetary policies 5. Fixed exchange rate would be more appropriate to avoid speculations CHAPTER EXERCISES Direction: Read the given scenario carefully and answer the question comprehensively. Support your answer. 1. When is money overvalued or undervalued? What is the effect of an undervalued currency in international trade? 2. Explain the foreign exchange market. What is a black market? 3. State one proposal for our monetary problem based on your own experience. Explain  Chapter 9 Monetary Policy Even the richest countries, like the United State and those of Western Europe, have encountered ups and downs in their economies. However, for the less developed countries, the serious problems of inflation and unemployment have persistently remained. Among the less developed countries, the rate of production has been extremely low. In case of unemployment, it is the product of low investment. There are very few factories, financial institutions and service industries. The level of investments is primarily determined by profits, political stability, peace and order, fair fiscal and monetary policies and demand for goods and services. The problems of inflation and unemployment are interdependent. The best cure for inflation is the production of more goods and services in order to meet he increasing demand for goods and services. Inflation aggravates unemployment problems. Based on the law of demand, when prices of goods and services increase quantity demand decreases, all other things being equal. This means people buy less number of goods and services during inflation due to the fall in their purchasing power. This results to less employment because of the decline in consumption. Producers have to cut down production relative to decrease in quantity demanded by consumers. In fight against inflation and unemployment, there are two major economic policies which being used, these are: Fiscal policy Monetary policy Monetary Theory Simply the theory of the value of money or the theory of the price level Value of money – amount of goods and services that we can buy with our money. - purchasing power of an individual Price level – amount of money given in exchange for goods and services Equation of money theory : M=P Quantity theory of Money A creation of the classical economists during the later part of 1700s MV=PQ M= quantity of money or money supply Q= number of goods and services P= average price level V= velocity of money Inflation There is inflation when there is a rising general level of prices It also aggravates unemployment problems Inflation is not favorable to many sectors of economy, particularly the fixed and low-income groups Types of Inflation 1. Demand-pull inflation Takes place whenever demand for goods and services is greater that supply Another cause of demand-pull inflation is the excess in money supply relative to the number of goods and services 2. Cost-push inflation This takes place whenever demand for goods and services is greater that supply 3. Structural Inflation This is a situation where supply fails to respond immediately to the demand for goods and services due to certain obstacles such as lack of transportation, scarcity of raw materials or lack of foreign exchange to import the required components of the products. Philippine experience The Philippine economy turned from bad to worse in 1984. Foreign loans were not granted. Dollars became very difficult to secure. Both domestic and foreign markets decline. Almost all economic sectors complained about the growing financial difficulties. Unemployment The problem of unemployment are widespread and deep seated in the less developed countries. In the Philippines there are more college graduates every year than the number of available jobs. These are the various causes of unemployment 1. Technology 2. Renovations 3. Business cycles 4. seasons Some of these are temporary in nature. However, the poor countries like Philippines, unemployment has become a permanent fixture. Many of those who are willing and able to work cannot find jobs. Theories of Employment One theory of employment was developed by the classical economist during the later part of 1700s. This classical theory of employment assumes that more jobs are created when wages are lower. This theory seems to justify the presence of many multi-national corporations in the less developed countries Another theory of employment was formulated by John Mynard Keynes, called the Father of Modern Economics. Keynes did not agree with the classical theory of employment. He argued, that during the Great Depression in the US in 1930s, workers were willing to accept jobs at any wage but could not find jobs. He stated that high wages could not be that main cause of unemployment. Keynesian Theory Classified as the modern theory of employment, claims that employment is created by aggregate demand. This refers to the total demand for goods and services by the government, business and household sectors. When aggregate demand rises, it means more market for goods and services. Such favourable economic condition induces more investments, such as textile factories, food processing companies, construction materials corporations, supermarkets, restaurants and service industries. Clearly, such investments create more jobs. Depression or Recession Aggregate demand is inevitably very low. During the Great Depression, the American government resorted to pump-priming activities. It conducted massive public works, upon the advise of Keynes, in order to create thousand of jobs. This increased the demand for goods and services because the people had incomes, and this was the beginning of the US economic recovery. Types of Unemployment 1. Frictional unemployment – this is caused by interruptions in production for technical reasons, or when workers are temporarily laid off due to renovation works 2. Structural unemployment – change in technology renders the skill of some workers obsolete. For Example, the application of modern machines in farming or the use of modern computers in offices reduces the need for the services of some workers. 3. Cyclical unemployment- fall of economic activities. Production has to be cut down and some workers have to be laid off. 4. Seasonal unemployment – seasonal economic activities, especially those in agriculture. More farm workers are employed during planting and harvesting seasons. After these, they are jobless. Monetary Policies Monetary Policy is a major economic policy, together with fiscal policy. It is the Monetary Board of the Bangko Sentral ng Pilipinas which formulates monetary policies. These are rules in attaining the objectives of Bangko Sentral such as monetary stability, full employment, and balanced economic growth. Bangko Sentral is equipped with monetary tools like open-market operations, rediscounting, legal reserves requirements and moral suasion. Professor James Boughton defined monetary policy as the process whereby the monetary authority attempts to achieve a desired set of goals by controlling credit either the money supply, the cost and availability of credit or the allocation of credit to the various users. In view of the shortcomings of the present financial system, the Bangko Sentral has launched a crusade for the sound and responsible banking. They are : prudence, service to the community and commitment to development efforts such as the mobilization of savings for investment purposes. Objectives of Monetary Board The Monetary Board formulates the monetary policies of the country. The Chairman of the Monetary Board is the Governor of the Bangko Sentral. It’s the Bangko Sentral which executes the monetary policies. The Major objective of monetary policies are: 1. Price stabilization – the Bangko Sentral through its monetary tools like, open market operations, interest rates, legal reserve requirements and moral suasion can stabilize price fluctuations especially inflations. When money is abundant and goods are scarce, the level of prices rises. The best way to fight inflation is to produce more goods. 2. Full employment – the Bangko Sentral can channel its resources, together with other financial institutions, towards the generation of jobs. 3. Economic growth – this is the result of economic development. Clearly, funds are needed for economic development. The construction of roads, bridges, communication facilities irrigation system, and the setting up of factories and other industries require huge capital. Limitation of Monetary policies Monetary policies are not effective during depression. Another limitation of monetary policies is the delays or lags involved in analyzing monetary and financial problems, the formulation of appropriate monetary policies to solve the monetary and financial problems, implementation of said monetary policies and finally, impact of such monetary policies on the problem Money markets and credit institutions are unorganized and fragmented in most less developed countries. In the Philippines, unlicensed moneylending is widespread, and the Bangko Sentral canot regulate their activities. In addition, many financial institutions in the less developed countries are branches of extension offices or multinational banks owned by the US, Japan, France, Great Britain and other European countries. Such global banks are more interested in the monetary policies of their own countries. Review of monetary and banking policy 1. Maintenance of reasonable level of international level The main reason of monetary authorities during the period of 1949-1960 was to maintain a reasonable level of international reserves. Such policy measures were intended to control and stabilize the demand for foreign exchange, particularly the US Dollars 2. Promotion of economic development In the 1960s, there was an increase in the money supply about 13% as a result, consumer price index rose to 14%. Such inflationary tendencies prompted the old Central Bank to increase its reserve requirement and rediscount rate to check the growth of money supply. During this period, the growth of the monetary policy was the promotion of economic development, such as the promotion of a rising level of production, employment and real income (purchasing power) 3. Maintenance of internal and external monetary stability In view of the growth of financial system especially with the rise of new forms of financial intermediaries. The central bank act was amended in 1972. The old central bank of the Philippines has been given another job as the central monetary authority. The principal focus of monetary policy was shifted from the promotion of economic development to the maintenance of internal and external monetary stability. CHAPTER EXERCISES Direction: Read the given scenario carefully and answer the question comprehensively. Support your answer. 1. What is the Difference between the Classical Theory and Keynesian Theory of employment? 2. Give your own personal views on our monetary policies. 3. Why do you think inflation feeds inflation? Explain.  Chapter 10 The Responsibilities of Fiscal Policy Fiscal and Monetary policy Aims to achieve the same economic objectives: Price stability Full employment Balanced economic growth Fiscal policy is basically involved in taxation and government expenditure. And if taxes are not enough to support government expenditure, borrowings – mostly foreign loans – are resorted to. This always happens to less developed countries like Philippines. It is evident that taxation, government expenditures and foreign borrowings have direct and tremendous effects on the price level employment and economic growth. If fiscal policies are not appreciate and these are mismanaged, this economic implications would be destructive to the whole economy. In this case, the primary objectives of the Bangko Sentral ng Pilipinas to promote monetary stability, employment and balanced economic growth are most likely to fail. Nature of Fiscal Policy Fiscal policy refers to the revenue and expenditure measures of the public budget. The formulation of fiscal policies involves voters, the President and his cabinet and the legislative body. In a real democratic society, the needs and interests of all sectors of the economy are expressed through the national budget. Since limited resources, the most basic needs of the people are given he first priority. Nevertheless, among the less developed countries, the economic and political interest of top government official are being promoted. For example, many government projects appear immediately before election time. Objectives of fiscal policy 1. Provision for social policy 2. Equitable distribution of wealth and income 3. High employment 4. Price stability 5. Satisfactory rate of growth The National budget contains specific provisions for the funding of projects and programs for the achievement of the aforementioned policy objectives. The president and his secretaries prepare the budget for deliberation and approval by the legislative. Fiscal Functions Fiscal word has been derived from the latin word “fiscus” which means money bag, This pertains to public treasury or revenue. The government collects revenues and spend these to fund various sectors of the economy such as education, agriculture, public works, national defense, health and so forth. Three Major Fiscal Functions 1. Allocation function – Private goods like shoes, cars, appliance and so forth are allocated in the market. Those who have money can acquire such goods in the market. However, in the case of social goods, many of them cannot be efficiently allocated in the market. 2. Distribution function – there is misdistribution of wealth and income in poor countries. Most of the productive resources belong to the privileged few. In a free market economy, income distribution is based on factor ownership. Laborers get their wages, landlords receive their rents, the capitalist earn their interest, and entrepreneurs create profit. 3. Stabilization function – economic stability is an important goal of fiscal policy. When there are no problems of inflation and unemployment, then the economy is said to be stable. The government through its fiscal tools – taxation, borrowings and expenditures- can minimize or reduce the problems or unemployment and inflation. Fiscal Politics In a democracy, the people elect their own representatives in the legislative body. Such representatives have their responsibility to work for the interests of their respective districts or regions. If they fail in their duties and responsibilities, the people change their through the election process with the persons whom they believe are more capable and responsive to the needs of their constituents. Clearly the merits of the project have been voted by members of the legislative body on the basis of political considerations and not on their economic importance. Likewise, some very powerful special groups with business interest can influence fiscal policies on taxation and government expenditures on certain pojects. Public Expenditures Expenditures of the government are indicated in the national budget which shows the specific programs and projects. Agricultural countries allocate a big portion of their budget on agriculture. Those countries which pursue their industrialization programs, naturally spend more funds for such economic goal. In short, public expenditures mirror thrusts of the national government. In view of the fast growth of our population, public expenditures have also tremendously increased to be able to meet the basic social services. They believe that human investment is the key to real economic growth. In other words, the development of people through education has been their top priority in their national economic development programs. Evaluating Public Expenditures It can be evaluated by comparing their cost and benefits. If benefits are greater than costs, then such expenditures have done efficiency. If the public expenditures have created more jobs, more products, more services more schools, more hospitals and more houses then such expenditures have substantially contributed to our economic growth. Economic efficiency of public expenditures is not he principal yardstick on evaluating the performance of our public expenditures. Among less developed countries, government expenditures should be evaluated more on their impact on the people. Social justice should be the first and last consideration in evaluating the merits of public expenditures. Government should channel most of its public expenditures into programs that can uplift the social and economic conditions of the poor masses. Real democracy cannot survive in any society where most of the people are very poor. Taxation Taxation is a means of raising funds for the operations of the government, especially its public services. In our country, huge funds are needed for the constructions of social and economic infrastructures like roads, bridges, communication and transportation facilities, schools, hospitals, irrigation system and electrication projects. These serves as the foundation of our economic growth. Competent observers also said that our tax system has been unjust to the poor who have to bear the burden of indirect taxes which are the main bulk of out taxation. Approaches to equitable taxation The citizens of any nation have the fundamental responsibility to contribute their “fair share” to cost of their government operations. Such contribution by every citizen is in the form of tax based on the concepts of ability to pay and benefits received. Tax has always been a burden to taxpayers, but if it is fair and that it is being used for public service, then such burden becomes less painful. Two principles of equitable taxation 1. Benefits received – people pay their taxes in proportion to the benefits that they receive from the government programs or projects. Examples of benefits received are postal services, use of roads and bridges with toll fees, public parks and beaches with entrance fees, government schools with tuition fees, and so forth. Those who do not pay are excluded from the consumption of said government services. However, there are government programs in which it is not possible to exclude those who do not pay, such as anti-pollution program in a community. 2. Ability to pay – people should pay their taxes based in their ability to pay. Such ability is measured by their incomes and wealth. Individuals whose incomes are within the same bracket pay equal taxes. This is equal sacrifice or equal burden in the taxpayers such ability to pay principle is more widely applied as the basis in determining out tax payments. Foreign Debt Also known as ballooning. The foreign debt of the less developed countries is more than $1.3 trillion. Such mountain of foreign debts indicate the depressed economic conditions of the poor countries. In fact many of them could not pay the WB, IMF and other international financial institutions. Strings Attached to foreign Loans Here are some examples of strings attached to foreign loans: 1. Favorable market for the products of the creditor countries 2. Employment of foreign consultations in the projects financed by foreign loans 3. Purchase of machines, materials and equipment from the creditor country to be used in the foreign assisted project 4. Creditor countries select the projects to be funded, and their constructions are subject to international bidding which is dominated by the multi-national corporations 5. Special privileges in the exploitations of the best natural resources of the borrowing countries.  Creditor countries are more inclined to extend loans to countries which give them economic, political and military benefits. Example is US and Japan. Foreign Loans for the Poor Foreign loans are beneficial to the economy if these are used to fuel the engines of economic development. Even the foremost economic nationalist Claro M. Recto favoured foreign loans. He stated that when we borrow money from abroad for our economic development, we become the capitalist and therefore retain the profits. They generate incomes which are more than enough to pay the yearly amortization of foreign loans. The LRT is very good example. It has not only created incomes for the government but also for many people. The negative effects of Fiscal policy Financial capital comes from savings. Such capital is needed to finance investments, such as the establishment of factories, supermarkets, schools, hospitals and other services and product industries. Clearly, more investment mean more employment, production and income. If the fiscal authorities formulate the wrong fiscal policies and even if the fiscal policies are correct but they are not properly implemented, then they only succeed in achieving the negative effects of fiscal policy. Some of the more important negative fiscal effects 1. Savings 2. Investments 3. Inflation 4. Employment 5. Consumption Limitation of Fiscal Policy Fiscal policy should be an instrument of social justice and economic prosperity. Fiscal policy making has become more of a political rather than an economic and social process. In many underdeveloped countries – where public administration in generally inefficient and corrupt – government officials are more interested in their political future. Fiscal policy – like monetary policy suffers from various lags or delays in the process of discussion of economic problems implementation of the appropriate fiscal policies and their subsequent effect. By the time a fiscal policy is ready for implementation, the economic problem may have change. Another weakness of fiscal policy is its inefficient implementation, particularly the administration of tax programs. Coordination of Fiscal and Monetary Policies Main goals of any economy 1. Price stability 2. Full employment 3. Sustainable balance economic growth 4. In the realization of such goals, both fiscal and monetary policies play a leading role Monetary authorities are technocrats who are appointed by politicians. On account of their professional competence, they are expected to be more objective in policy formulation compared with fiscal