BASIC FINANCE CH 8 – REPLACES

THE CHAPTER IN THE BOOK

• THIS CHAPTER FOCUSES ON

THE CENTRAL BANK – CALLED
BANGKO SENTRAL NG
PILIPINAS IN THE PHILIPPINES
 FIRST, REMEMBER FROM ECONOMICS
1) BUSINESS CYCLE: GROWTH, PEAK,
RECESSION, TROUGH, RECOVERY, GROWTH,
ETC….

2) FISCAL POLICY IS GOVERNMENT TAKING IN

TAXES AND THEN SPENDING (FOR THINGS LIKE
ROADS, BRIDGES, PUBLIC TRANSPORTATION,
HOSPITALS)…CAN CREATE JOBS AND EXPAND
THE ECONOMY – OR BE USED TO CONTRACT
THE ECONOMY IF YOU TAX MORE OR SPEND
LESS, ETC..
 NOW, THE OTHER POLICY –
MONETARY POLICY
• DEALS WITH THE CENTRAL BANK…..
 THE CENTRAL BANK – BANGKO
SENTRAL NG PILIPINAS DOES:
Monetary Policy – When? For
example if there is a recession….

First, a review of
what the central
bank is
 What is the Central Bank?
• Independent of the government, they set the
monetary policy (issue the money, monitor
the banks, and control SHORT TERM
INTEREST RATES)

• In the USA, called the Federal Reserve Bank

in (¨The Fed¨), in Europe, called the European
Central Bank (¨ECB¨), and in the Philippines,
Bangko Sentral ng Pilipinas (“BSP”)
 Why autonomy?
What does the BSP’s autonomy consist of?

In order to fulfill its mission, the BSP must enjoy

autonomy (independent, not controlled by the
government)
 BSP (Bangko Sentral ng Pilipinas)
What are the functions of the BSP?
The BSP functions, as defined by the Constitution, include the
following:
-to regulate money and credit in the financial system

- manage international reserves

- issue notes and coins

- periodically report on the country’ finances

Prints the money (in all countries
BSP has this role)
BSP (Bangko Sentral ng Pilipinas)
 BSP (Bangko Sentral ng Pilipinas)
• What is the mission of the BSP?

The objective of the BSP is to preserve

monetary stability.

The BSP has established an inflation target of

4.0% for 2014-15 and 3.0% (2-4% RANGE) for
2015-16
BSP accomplishes this through increasing or
decreasing the money supply (“monetary
policy) nang
 BSPs website
• http://www.bsp.gov.ph/monetary/targeting.a
sp
 BSP – view on inflation
Inflation is detrimental to economic
development because it prevents money from
adequately fulfilling its functions as a medium of
exchange and as a store of value

Inflation discourages investment - the

devaluation of money resulting from continuous
rises in the prices of goods and services affects
interest rates and thus both consumers and
businesses
 Rise in inflation
If interest rates rise too much,
businesses stop borrowing money
for projects and expanding

Leads to slower growth in an

economy), and consumers borrow
less
 What can inflation lead to?
• In a worst case, a recession

• A recession is a DECLINE in economic

activity for at least six months (two
consecutive 3-month quarters)
 BSP
• Therefore, BSP tries to have low
inflation to create necessary
conditions for normal economic
activity

• Contributes to achieve higher levels

of sustained economic growth
 What is Monetary policy (by the
BSP)?

 It is a macroeconomic
policy which involves the
regulation of the money
supply, credit and interest
rates in order to control the
level of spending in the
economy
 Expansionary monetary
policy

 It refers to a monetary policy

setting that intends to increase
the level of liquidity/money
supply in the economy and
which could also result in a
relatively higher inflation path
for the economy
 Contractionary monetary
policy

 Itintends to decrease the level

of liquidity/money supply in the
economy and which could also
result in a relatively lower
inflation path for the economy
 BSP’s Monetary Policy Instruments
1- Raising (or reducing) the BSP’s policy interest rates.
Raising = decreasing money supply = contractionary.
Reducing = expansionary

How? by increasing (decreasing) its rediscount rate on loans

extended to banking institutions on a short-term basis against
eligible collaterals of banks’ borrowers:
The BSP’s primary monetary policy instruments are the
overnight reverse repurchase (borrowing) rate and the overnight
repurchase (lending) rate.

2 - outright sales (purchases) of the BSP’s holdings of

government securities TO DECREASE (INCREASE) THE
MONEY SUPPLY

3- increasing (decreasing) the reserve requirement

 Outright sales (purchases) of the BSP’s
holdings of government securities:
BSP BUYS BONDS (FROM BANKS) - EXPANSIONARY
• PAYS FOR BONDS WITH CASH – BANKS GET
THE CASH INCREASING THE MONEY SUPPLY
AND LOAN IT OUT TO CUSTOMERS, WHO
SPEND THE BORROWED MONEY, EXPANDING
THE ECONOMY

BSP SELLS BONDS (TO BANKS) - CONTRACTIONARY

• BANKS PAY FOR BONDS WITH CASH – BANKS
USE UP CASH DECREASING THE MONEY
SUPPLY AND CANT MAKE AS MANY LOANS –
LEADING TO LESS BORROWING, LESS
 SO, for EXAMPLE: what does the BSP
do about a recession?
• They 1) decrease short term interest rates (the
rates they have control of), or 2) buy
government securities, or 3) lower the reserve
requirement

• TO GET DESIRED EFFECT: For example, decreasing

short term interest rates leads to a decrease in
medium to long term interest rates (by market
forces), which enables companies and people to
borrow again
 BSP tries to revive the economy

• Sometimes the Central Bank

has to cut interest rates
several times before hte
economy responds, but we
eventually get a response
AND RECOVERY
 When companies and people borrow again

• Consumers start spending more

• Companies doing projects for growth

(expanding their business).

• When they are spending and

building/expanding more, then more
workers are needed (unemployment
declines)
 Central Bank to the rescue
• The new workers, the ones that previously
had lost their jobs then have more income

• They start spending their new money, and

that helps the businesses that they purchase
from

• Those businesses, with new customers, then

have to hire more workers, etc…..
 Central Bank at work
http://www.youtube.com/watch?v=xzwZJ0PHe-E

http://www.federalreserve.gov/monetarypolicy/openmarket.htm

http://money.cnn.com/2008/10/08/news/economy/fed_move/

http://www.moneycafe.com/personal-finance/fed-funds-rate/

http://www.youtube.com/watch?v=wrjOLNH7W2E music
 Bubbles
people get too overconfident and
overinvesting, causing a unsustainable growth
with an ugly, ending, here is what the
Japanese stock market did

• http://finance.yahoo.com/echarts?s=%5En225+interactive#symbol=^n225;range=my;compar
e=;indicator=volume;charttype=area;crosshair=on;ohlcvalues=0;logscale=off;source=undefine
d;
 Practice questions
• Why is it bad for the economy to “overheat”?

• What does the central bank do to try to slow

inflation?

• What if we are in a recession and the central

bank has lowered interest rates, who else can
make a difference? How?
 Practice – True or False?
Monetary policy regulates government spending and taxes

Expansionary monetary policy increases the money supply

Contractionary monetary policy decreases reserve requirements

Expansionary monetary policy increases the money supply in an

economy

Expansionary monetary policy increases interest rates

BSP buys bonds for expansionary monetary policy

Monetary policy is done by the President