GROUP 3 FINN 21A

THE BANGKO SENTRAL NG PILIPINAS

DEPOSIT EXPANSION AND MONEY SUPPLY
 CHAPTER 5: The Bangko Sentral ng Pilipinas

What is Bangko Sentral ng Pilipinas?

The Bangko Sentral ng Pilipinas ( Central Bank of the Philippines, commonly abbreviated as BSP)
is the central bank of the Republic of the Philippines. It was established on July 3,1993. It enjoys fiscal
and administrative autonomy from the National Government in the pursuit of its mandated
responsibilities. It has three regional offices performing cash operations, cash administrations, loans and
rediscounting, bank supervision and gold buying operations. Regional offices are located in La Union,
Cebu City and Davao City.

The BSP's primary objective is to maintain price stability conducive to a balanced and
sustainable economic growth. It aims to promote and preserve monetary stability and the convertibility
of the national currency.

BSP Vision

The BSP aims to be recognized globally as the monetary authority and primary financial system
supervisor that supports a strong economic and promotes a high quality of life for all Filipinos.

BSP Mission

To promote and maintain price stability, a strong financial system, and a safe and efficient
payments and settlements system conducive to a sustainable and inclusive growth of the economy.

Brief History

In early 1933, a group of Filipinos had conceptualized a central bank for the Philippines. It came
up with the rudiments of a bill for the establishment of a central bank for the country after a careful
study of the economic provisions of the Hare-Hawes cutting bill, the Philippine Independence bill
approved by the US Congress.

During the Commonwealth period (1935-1941), there was a discussion about a Philippine
Central Bank that would promote price stability and economic growth continued. Also, the country's
monetary system then was administered by the Department of Finance and the National Treasury.

Wayback 1939, as required by the legislature passed a law establishing a central bank. It was a
monetary law, it required the approval of the United States President. But, President Franklin D.
Roosevelt disapproved it due to strong opposition from vested interests.

In 1944 during the Japanese Occupation, a second law was passed in but the arrival of the
American liberalization forces aborted its implementation.
 After President Manuel Roxas assumed office in 1946, he instructed then Finance Secretary
Miguel Cuaderno, to draw up a charter for central bank. The commission which studied Philippine
Financial, monetary and fiscal problems in 1947, recommended a shift from the dollar exchange
standard to a managed currency system. And, the central bank was necessarily in order to implement
the proposed shift to the new system.

Immediately, the central bank council, which was created by President Manuel Roxas to prepare
the charter of a proposed monetary authority, produced a draft. Then, it was submitted to Congress in
February 1948. By June (same year), the newly-proclaimed President Elpidio Quirino, who succeded
President Roxas affixed his signature on Republic Act No. 265, the Central Bank Act of 1948.

By June of the same year, the newly-proclaimed President Elpidio Quirino, who succeeded
President Roxas, affixed his signature on Republic Act No. 265, the Central Bank Act of 1948.

Over the years, changes were introduced to make the charter more responsive to the needs of
the economy. On November 29, 1972, Presidential Decree No. 72 adopted the recommendations of the
Joint IMF-CB Banking Survey Commission which made a study of the Philippine Banking System. Then,
the commission proposed a program designed to ensure the system's soundness and healthy growth.

There's a subsequent changes sought to enhance the capability of the Central Bank, in the light
of a developing economy, to enforce banking laws and regulations. In 1973 Constitution, the National
Assembly was mandated to establish an independent Central Monetary Authority.

Later, PD1801 designated the Central Bank of the Philippines as the Bank Central Monetary
Authority (CMA). Years passed, the 1987 Constitution adopted the provisions on the CMA from the 1973
Constitution that were aimed essentially at establishing an independent monetary authority through
increased capitalization and greater private sector representation in the Monetary Board.

The administration that followed the transition government of Pres. Corazon C. Aquino saw the
turning of another chapter in Philippine Central Banking. In accordance with 1987 Constitution,
President Fidel V. Ramos signed into law Republic Act No. 7653, the new Central Bank Act on June
14,1993. Also, one law provides for the establishment of an independent monetary authority to be
known as the Bangko Sentral ng Pilipinas, with the maintenance of price stability explicitly stated its
primary objective. Also, the Law gives the Bangko Sentral fiscal and administration autonomy which the
old Central Bank did not have. On July 3,1993, the New Central Bank Act took effect.
The Balance Sheet

BANGKO SENTRAL NG PILIPINAS

BALANCE SHEETS

December 31, 2018 and 2017

(In Philippine Peso)

Note 2018 2017

(as restated)
ASSETS

FOREIGN CURRENCY FINANCIAL ASSETS 2.7/2.8.3/2.9

International reserves
Deposits with foreign banks 6 1,123,248,162,540 831,774,930,689
Other cash balances 7 1,131,822,894 233,178,718
Investment securities 8 2,134,396,095,054 2,719,308,711,490
Foreign securities purchased under
agreements 9 388,368,175,329 25,521,651,156
to resell 10 2,111,092,664 2,687,564,509
Loan to International Monetary Fund 11 428,575,278,987 416,509,798,557
Gold
International Monetary Fund special drawing 12 62,332,053,326 60,560,217,620
Rights
Gross international reserves 4,140,162,680,794 4,056,596,052,739

Other foreign currency receivables 14 93,407,616,337 91,737,573,734

Non-international reserve foreign currency 38 33,255,679 32,471,204
Derivative instruments in a net gain/
(loss) position 2.8.3/2.19 52,562,590 95,503,927
Total foreign currency financial assets 4,233,656,115,400 4,148,461,601,604

LOCAL CURRENCY FINANCIAL ASSETS 2.9

Investment securities 15 223,298,756,824 224,616,052,975
Loans and advances (net) 13 277,505,654,368 187,418,147,176
Due from administrator of funds 2.22.1 to 4; 30,583,503,441 30,629,080,185
2.23.1 to 5;
16
Other receivables (net) 14 33,092,816,225 20,495,024,262
Total local currency financial assets 564,480,730,858 463,158,304,598
Total financial assets 4,798,136,846,258 4,611,619,906,202
OTHER ASSETS
Acquired assets held for sale (net) 2.11/17 152,911,842 51,270,390
Investment property (net) 2.12/18 13,874,714,761 15,164,218,665
Bank premises, furniture, fixtures and
equipment (net) 2.13/19 23,725,039,436 23,089,504,608
Intangible assets (net) 2.14/20 234,255,304 217,016,705
Inventories (net) 2.16/21 10,689,227,749 8,046,770,622
Property dividend to NG 27.a 285,214,339 285,214,339
Deferred tax assets 2.29/40.2 2,655,842,837 6,147,803,403
Miscellaneous assets 22 1,537,314,241 2,270,946,451
Total other assets 53,154,520,509 55,272,745,183

TOTAL ASSETS 4,851,291,366,767 4,666,892,651,385

Note 2018 2017

(as restated)
LIABILITIES AND CAPITAL

FOREIGN CURRENCY FINANCIAL LIABILITIES 2.7/2.8.3/2.18

Short-term deposits 23 94,492,769,739 16,101,750,255
Loans payable 24 3 0,358,818 30,448,468
Bonds payable 25 26,290,224,840 24,986,493,216
Allocation of International Monetary
Fund special drawing rights 26 61,368,543,843 59,856,929,020
Other liabilities 27 5 ,644,763,050 6,387,959,404
Total foreign currency financial liabilities 187,826,660,290 107,363,580,363

LOCAL CURRENCY FINANCIAL LIABILITIES 2.18

Government deposits 28.a 76,704,188,049 311,708,438,631
Deposits of banks and quasi banks 28.b 1,882,212,579,334 1,902,087,916,172
Deposits of International Monetary Fund
and other financial institutions 28.c 122,832,915,784 115,052,829,070
Securities sold under agreements to
repurchase 2.20.2 300,986,093,187 305,057,187,465
Term deposit account 2.20.4 69,195,712,862 100,957,502,580
Overnight deposit account 2.20.3 58,643,762,312 85,472,352,969
Total local currency financial liabilities 2,510,575,251,528 2,820,336,226,887
Total financial liabilities 2,698,401,911,818 2,927,699,807,250
OTHER LIABILITIES
Currency in circulation 2.21/29 1,490,240,285,960 1,267,269,736,898
Retirement benefits obligation 2.22/27 2,962,060,302 2,998,141,788
Miscellaneous liabilities 27 7,818,029,509 6,231,040,535
Dividend payable 2.28/27.a 449,345,216 449,345,216
Deferred tax liability 2.29 8 ,943,093 7,444,379
Revaluation of foreign currency accounts 2.8.3/30 534,976,388,056 381,544,827,570
Total other liabilities 2,036,455,052,136 1,658,500,536,386
TOTAL LIABILITIES 4,734,856,963,954 4,586,200,343,636

CAPITAL ACCOUNTS
Capital 31.a 50,000,000,000 50,000,000,000
Surplus/(deficit) 31.b (9,276,999,393) (45,604,257,360)
Unrealized losses on investments in
government securities 31.c (1,807,783,041) (1,324,097,853)
Capital reserves 2.23/31 77,519,185,247 77,620,662,962
TOTAL CAPITAL ACCOUNTS 116,434,402,813 4,666,892,651,385

TOTAL LIABILITIES AND CAPITAL ACCOUNTS 4,851,291,366,767 4,666,892,651,385

MAJOR POWERS OF BSP: MONETARY POLICY

Monetary Policy is the monitoring and control of money supply by a central bank. This is used by
the government to be able to control inflation and stability currency.

It is generally the process by which the central bank or government controls the supplies and
availability of money, the cost of money, and the rate of interest.

The primary objective of BSP's monetary policy is to promote a low and stable inflation
conducive to a balanced and sustainable economic growth.

Monetary Board

The powers and function of Bangko Sentral are exercised by its Monetary Board which has seven
members appointed by the President of the Philippines.

In the exercise of its authority, the Monetary board shall:

1. Issue rules and regulations is considers necessary for the effective discharge of the responsibilities
and exercises of the powers vested upon the Monetary Board and the Bangko Sentral.

2. Direct the management, operations, and administration of the Bangko Sentral, reorganize its
personnel, and issue such rules and regulations as it may deem necessary or convenient for this
purpose. The legal units of the Bangko Sentral shall be under the exclusive supervision and control of the
Monetary Board.

3. Establish a human resource management system which shall govern the selection, hiring,
appointment, transfer, promotion, or dismissal of all personnel. Such system shall aim to establish
professionalism and excellence at all levels of the Bangko Sentral in accordance with sound principles of
management.

4.Adopt an annual budget for and authorize such expenditures by the Bangko Sentral in the interest of
the effective administration and operations of the Bangko Sentral in accordance with applicable laws
and regulations.

5. Indemnify its members and other officials of the Bangko Sentral, including personnel of the
departments performing supervision and examination functions against all costs and expenses
reasonably incurred by such persons in connection with any civil or criminal action, suit or proceedings
to which he may be, or is, made a party by reason of the performance of his functions or duties, unless
he is finally adjudged in such action or proceeding to be liable for negligence or misconduct.

Monetary Board also exercises the powers and functions of the BSP, such as the conduct of
monetary policy and supervision of the financial system. Its chairman is the BSP Governor, with five full-
time members from the private sector and one member from the Cabinet.
Governor

Chief Executive Officer of the BSP and is required to direct and supervise the operations and
internal administration of the BSP.

A Deputy Governor (Senior Assistant Governor) heads each of the BSP's operating sector as follows:

1. Monetary and Economics Sector is mainly responsible for the operations/activities related to
monetary policy formulation, implementation, and assessment.

2. Financial Supervision Sector is mainly responsible for the regulation of banks and other BSP-
supervised financial institutions.

3. Currency Management Sector is mainly responsible for the forecasting, production, distribution, and
retirement of Philippine currency.

4. Corporate Services Sector is mainly responsible for the effective management of corporate strategy,
communications, and risks.

Major Powers and Responsibilities

The BSP provides policy directions in the areas of money, banking and credit. Also, supervises
operations of banks and exercises regulatory powers over non-bank financial institutions with quasi-
banking functions.

The BSP performs the following under the New Central Bank Act:

1. Liquidity Management. They implement and formulate monetary policy which aimed to influence
money supply to achieve its primary objective.

2. Currency issue. They have the exclusive power to issue the national currency. All notes and coins
issued by the BSP are fully guaranteed by the Government and are considered legal tender in the
Philippines for all private and public debts.

3. Lender of last resort. For liquidity purposes, the BSP extends discounts, loans and advances to
banking institutions.

4. Financial Supervision. The BSP supervises banks and exercises regulatory powers over non-bank
institutions performing quasi-banking functions.

5. Management of foreign currency reserves. In order to preserve international stability and

convertibility of the Philippine peso, the BSP seeks to maintain sufficient international reserves to meet
any foreseeable net demands for foreign currencies.

6. Determination of exchange rate policy. The BSP determines the exchange rate policy of the
Philippines. Currently, the BSP adheres to a market-oriented foreign exchange rate policy such that the
role of Bangko Sentral is principally to ensure orderly conditions in the market.
7. Other activities. Aside from its major powers and responsibilities stated above, the BSP also functions
as the banker, financial advisor and official depository of the Government, its political subdivisions and
instrumentalities and government-owned and -controlled corporations.

BSP CONTROL OF MONEY SUPPLY

What is Money Supply?

Money Supply is the entire stock of currency and other liquid instruments circulating in the
country's economy as of a particular time. It can also include cash, coins and balances held in checking
and savings accounts, and other near money substitutes.

The changes in the money supply are closely watched because of the relationship between
money and macro-economic variables such as inflation.

What is inflation?

Inflation is the increase in the prices of goods and services over time.

How does the BSP control money supply?

The primary objective of the BSP's monetary policy is “to promote price stability conducive to a
balanced and sustainable growth of the economy” (Republic Act 7653). Also, the adoption of inflation
targeting framework of monetary policy in January 2002 is aimed at achieving this objective.

Due to the changes as a result of the relationship between money and macro economic
variables such as inflation, the BSP implement its objective "the inflation targeting".

What is Inflation Targeting?

Inflation targeting is focused mainly on achieving a low and stable inflation, supportive of the
economy’s growth objective.

In order to achieve the inflation target, the BSP uses a suite of monetary policy instruments in
implementing the desired monetary policy stance.

Monetary Policy Instrument includes:

1. Reverse repurchase (RRP) or borrowing rate is the primary monetary policy instrument of the BSP.

2. Encouraging/discouraging deposits under the term deposit auction facility (TDF).

3. Standing liquidity facilities, namely, the overnight lending facility (OLF) and the overnight deposit
facility (ODF).

4. Increasing/decreasing the reserve requirement.

5. Adjusting the rediscount rate on loans extended to banking institutions on a short-term basis against
eligible collateral of banks' borrowers.

6. Outright sales/purchases of the BSP's holding of government securities.

The following is how the BSP control the money supply:

1. Reverse repurchase facility.

With the implementation of the IRC system, the RRP facility was transformed into an overnight
facility and offered using a fixed-rate and full-allotment method, where individual bidders are awarded a
portion of the total offer depending on their bid size. Fixed-rate, full allotment method will help ensure
that the overnight rate sits close to the BSP policy rate. The features of the O/N RRP facility can be
accessed on the monetary operations page.

2. Acceptance of term deposits.

The BSP, like other central banks, offers term deposits as one of the monetary tools to absorb
liquidity. Last November 1998, the Bangko Sentral offered the Special Deposit Accounts (SDA) to banks
and trust entities of banks and non-bank financial institutions. With the adoption of the IRC system in
2016, the SDA facility was replaced by the term deposit auction facility (TDF).

What is TDF?

TDF is a key liquidity absorption facility used by the BSP for liquidity management and used to
withdraw a large part of the structural liquidity from the financial system to bring market rates closer to
the BSP policy rate.

3. Standing liquidity facilities

The Bangko Sentral ng Pilipinas offers standing liquidity (which is lending and deposit) windows
that help counterparties adjust their liquidity positions at the end of the day. These standing overnight
facilities are available on demand to qualified counterparties during BSP business hours. The two
standing facilities that form the upper and lower bound of the corridor are set at ± 50 basis points (bps)
around the target policy rate (the overnight RRP rate under the new IRC structure).

4. Rediscounting

In order to influence the volume of credit in the financial system, the BSP extends discounts,
loans and advances to banking institutions. Also, the rediscounting facility allows a financial institution
to borrow money from the BSP using promissory notes and other loan papers of its borrowers as their
collateral.
Rediscounting has two categories:

• Peso Rediscount Facility

Peso Rediscount Facility interest rates are based on the latest avialable BSP overnight lending
rate plus the applicable term premia per Circular No. 964 dated 27 June 2017.

• Exporters Dollar and Yen Rediscount Facility (EDYRF)

EDYRF interest rates are based on the 90-day London Inter-Bank Offered Rate for the last
working day of the immediately preceding month plus 200 basis points plus the applicable term premia
for loan maturities exceeding 90 days pursuant to Circular No. 807 dated 15 August 2013.

5. Reserve Requirements

Reserve requirements refer to the percentage of bank deposits and deposit substitute liabilities
that banks must set aside in deposits with the BSP which they cannot lend out, or where available
through reserve-eligible government securities. Changes in reserve requirements have a significant
effect on money supply in the banking system, making them a powerful means of liquidity management
by the BSP.

Also, it is imposed on the peso liabilities of universal/commercial banks (UBs/KBs), thrift banks
(TBs), rural banks (RBs) and cooperative banks (Coop Banks), and non-bank financial institutions with
quasi-banking functions (NBQBs). Reservable liabilities include demand, savings, time deposit and
deposit substitutes (including long-term non-negotiable tax-exempt certificates of time deposit or
LTNCTDs).

News Article Link

https://www.google.com/amp/s/business.inquirer.net/262975/bsp-seen-easing-monetary-policy/amp

Video Link

https://www.youtube.com/watch?feature=youtu.be&v=5yv1QCkCUpY&app=desktop

Research Link

http://www.bsp.gov.ph/downloads/Publications/2018/WPS201802.pdf
Sources

http://www.bsp.gov.ph/monetary/overview.asp

https://www.thebalance.com/what-is-inflation-how-it-s-measured-and-managed-3306170

https://econlib.org

http://www.bsp.gov.ph/about/vision.asp

http://www.bsp.gov.ph/about/financial.asp
 CHAPTER 6: DEPOSIT EXPANSION AND MONEY SUPPLY

DEPOSIT EXPANSION

• is a function used to describe the amount of money a bank creates in additional money supply
through the process of lending the available capital it has in excess of the bank's reserve requirement.

• It is also known as deposit multiplier, deposit expansion multiplier.

• It is the amount of cash that a bank must keep in reserve and is a percentage of the amount on
deposit at the bank. For example, if the deposit multiplier is 20% the bank must keep $1 in reserve for
every $5 it has in deposits. The remaining $4 is available to the bank to loan out or invest.

• The deposit multiplier requirement is key to maintaining an economy's basic money supply.
Reliance on a deposit multiplier is called a fractional reserve banking system and is now common to
banks in most nations around the world.

Fractional Reserve Banking

- Fractional reserve banking is a banking system in which banks only hold a fraction of the money
their customers deposit as reserves.

- This allows them to use the rest of it to make loans and thereby essentially create new money.

- Affects money supply

- Central banks are in charge of money supply

Understanding Deposit Expansion

Keeping a deposit multiplier minimizes the risk that a bank will not have enough cash on hand to
satisfy day-to-day withdrawal requests from its customers. Its reserve requirement ratio also determines
how much money it has to loan out or otherwise invest.

[Important: Banks may keep reserves beyond the requirements set by the Federal Reserve in order to
reduce the number of checkable deposits.]

Expansion through Bank Investments

Deposit expansion can proceed from investments as well as loans. Suppose that the demand for
loans at some banks is slack, these banks would then probably purchase securities. If the sellers of the
securities were customers, the banks would make payment by crediting the customers' transaction
accounts; deposit liabilities would rise just as if loans had been made. More likely, these banks would
purchase the securities through dealers, paying for them with checks on themselves or on their reserve
accounts. These checks would be deposited in the sellers' banks. In either case, the net effects on the
banking system are identical with those resulting from loan operations.

Checkable deposits – funds held at bank or any other financial institutions a means for people to quickly
access their accounts by writing checks or drafts.
 Problem: Financial crisis occurs when the fractional banking system breaks down and the money
supply does not expand, money banks have to shut down during the great depression because so many
people attempted to withdraw at the same time. Today safeguard exist to avoid such an a occurrence.

Safeguard- is a series of initiatives to protect your hard-earned money and savings from misuse of the
financial system for financial crime. This involves strengthening our ability to combat money laundering
and the evasion of sanctions, as these are often the drivers behind financial crimes.

Central banks such as the Federal Reserve in the United States establish minimum amounts to
be held by banks, known as the required reserve and controls the monetary base. The bank must
continually maintain this minimum in an account deposited at the central bank to ensure that it has
sufficient cash to meet any withdrawal requests from its depositors.

The deposit multiplier is sometimes expressed as the deposit multiplier ratio, which is the
inverse of the required reserve ratio. For example, if the required reserve ratio is 20%, the deposit
multiplier ratio is 80%.

The reserve ratio is the percentage of depositors' bank balances that the banks have on hand. So
if a bank has $10 million in deposits, and $1.5 million of those are currently in the bank, then the bank
has a reserve ratio of 15%.

Deposit Multiplier Vs Money Multiplier

The deposit multiplier is frequently confused with the money multiplier. Although the two terms
are closely related, they are not interchangeable.

The money multiplier reflects the change in a nation's money supply created by the loan of
capital beyond the bank's reserve. It can be seen as the maximum potential creation of money through
the multiplied effect of all bank lending.

If banks loaned out every available dollar beyond their required reserves, and if borrowers spent
every dollar they borrowed from banks, the deposit multiplier and the money multiplier would be
essentially the same.

In practice, banks do not lend out every dollar they have available. And not all borrowers spend
every dollar they borrow. They may devote some of the cash to savings or other deposit accounts. That
reduces the amount of money creation and the money multiplier figure that reflects it.

Key points:

• It is the main component of a fractional reserve banking system.

• Banks in the U.S. must keep minimums set by the Federal Reserve but may set a higher deposit
multiplier.
Bank Reserve

A bank reserve is the currency deposit that is not lent out to the bank's clients. A small fraction
of the total deposits is held internally by the bank in cash vaults or deposited with the central bank.
Minimum reserve requirements are established by central banks in order to ensure that the financial
institutions will be able to provide clients with cash upon request.

How Bank Reserves Work

Bank reserves are typically held by financial institutions to avoid bank runs and have sufficient
cash on hand, should an unexpected and large withdrawal request come up. Bank reserves are divided
into required reserves and excess reserves. Because of the banking industry's importance to the
economy, national authorities regulate banks by obligating them to hold a certain amount of required
reserves with central banks.

Excess reserves - represent any vault cash that banks hold that is in excess of the required reserves
amount. Banks typically have a low incentive to maintain excess reserves because cash earns the rate of
return of zero and can lose value over time due to inflation. Thus, under normal circumstances, banks
minimize their excess reserves and lend out money to clients rather than holding cash in their vaults.
Bank reserves decrease during periods of economic expansion and increase during recessions.

Recession - is a business cycle contraction when there is a general decline in economic activity
Recessions generally occur when there is a widespread drop in spending (an adverse demand shock).
This may be triggered by various events, such as a financial crisis, an external trade shock.

The required reserve ratio can be used by national authorities as a tool to implement monetary
policies. Through this ratio, a central bank can influence the amount of funds available for borrowing.
Beginning in October 2008, the Federal Reserve began paying interest to the banks for required and
excess reserves as a way to infuse more liquidity into the U.S. monetary circulation.

Monetary policy - consists of the process of drafting, announcing, and implementing the plan of actions
taken by the central bank, currency board, or other competent monetary authority of a country that
controls the quantity of money in an economy and the channels by which new money is supplied.

There are two other ways in which the System can affect bank reserves and potential deposit
volume directly: first, through loans to depository institutions; and second, through changes in reserve
requirement percentages. A change in the required reserve ratio, of course, does not alter the volume of
reserves directly but does change the amount of deposits that a given amount of reserves can support.

Any change in reserves, regardless of its origin, has the same potential to affect deposits.
Therefore, in order to achieve the net reserve effects consistent with its monetary policy objectives, the
Federal Reserve System continuously must take account of what the independent factors are doing to
reserves and then, using its policy tools, offset or supplement them as the situation may require.

Holding more currency tends to decrease the money supply. How much currency is held by the
public depends on costs and benefits. The opportunity cost of currency is the interest that it would earn
as a deposit compared to the advantages of lower risk and greater liquidity as currency. Hence, the
public will hold less currency if it can earn higher interest rates as a deposit. Likewise, the higher the
interest rate difference between lent money and reserves, the less likely that banks will keep excess
reserves.
BSP’S CONTROL OF DEPOSIT EXPANSION

Open Market Operations

- An unrestricted market with free access by and competition of buyers and sellers

- Generally refer to an economic situation close to free trade

Mechanics of OMO

OMO is a monetary tool which involves the BSP publicly buying or selling government securities
from banks and financial institutions in order to expand or contract the supply of money. By controlling
the money supply, the BSP is able to exert some influence on the prices of goods and services and
achieve its inflation objectives.

When the BSP buys securities, it pays for them by directly crediting its counterparty’s Demand
Deposit Account that is being maintained with the BSP. Effectively, the transaction increases the buyer’s
level of reserves and on an aggregate level, expands the system’s money supply. Conversely, when the
BSP sells the securities, the buyer’s payment (via direct debit against the buyer’s Demand Deposit
Account with the BSP) reduces his reserve account causing money supply to contract.

In conducting OMO, the BSP uses two instruments: (1) repurchase (repo)/reverse repurchase (reverse
repo) agreements and (2) outright purchases and sales of securities.

• Repurchase (repo) / reverse repurchase (reverse repo) agreements. The BSP purchases
government securities from a bank with a commitment to sell it back at a specified future date at a
predetermined rate. In effect, a repo transaction expands the level of money supply as it increases the
bank’s level of reserves. Under a reverse repo, the BSP acts as the seller of government securities, thus,
the bank’s payment reduces its reserve account resulting in a contraction in the system’s money supply.
For both repos, the BSP can only affect the level of money supply temporarily, given that the parties
involved commit to reverse the transaction at an agreed future date. At present, the BSP enters into
repo agreements for a minimum of one (1) day (overnight) for both repos and a maximum of 91 days
and 364 days for repo and reverse repo agreements, respectively.

• Outright purchases and sales of securities. An outright contract involves direct purchase/sale of
government security by the BSP from/to the market for the purpose of increasing/decreasing money
supply on a more permanent basis. In such a transaction, the parties do not commit to reverse the
transaction in the future, creating a more permanent effect on the banking system’s level of money
supply.

The BSP may also use other monetary policy tools such as reserve requirements and
rediscounting to expand or contract money supply. The BSP may also grant loans and advances to
banking institutions to influence the volume of credit consistent with the objective of price stability. In
addition, the BSP can employ moral suasion as a last resort when existing market mechanisms cannot
adequately and promptly ensure the attainment of specific monetary objectives.
Advantages of Open Market Operations

However, among the tools available to the BSP, OMO offers advantages and continues to be the most
practical tool for the following reasons:

• First, it works within the BSP’s initiative and control. Having the authority to steer market
interest rates, the BSP can influence money supply by changing the monetary policy rates.
Consequently, OMO gives the BSP greater flexibility in terms of the amount and timing of intervention.

• Secondly, it is fast to implement and gives quick results. Any change in the policy rates is readily
implemented, i.e., on the same day that the Monetary Board makes the resolution. Thus, any effect on
the market is evident right after the overnight trading for the day.

FACTORS AFFECTING DEPOSIT EXPANSION

• Increase in National Income

National income refers to the money value of all goods and services produced in a country during a
financial year

• Increase of banking facilities in new area and for new class of people

• Increase in banking habit

• Increase In relative rate of return

Rate of return on investment is income earned by investing in assets and it is measure mostly in
percentage terms.

• Increase in deficit financing

The central bank uses deficit financing to finance its budget deficit either by issuing government
securities like treasury bills and bonds, selling domestic debt to foreign nations, minting new money or
liquidating its assets or sovereign wealth fund.

• Increase in bank credit

• Inflow of deposit by NRIs

• Loan Growth

PUBLIC PREFERENCES

Changes in the amount of currency held by the public typically follow a fairly regular intra
monthly pattern. Major changes also occur over holiday periods and during the Christmas shopping
season - times when people find it convenient to keep more pocket money on hand. The public acquires
currency from banks by cashing checks. When deposits, which are fractional reserve money, are
exchanged for currency, which is 100 percent reserve money, the banking system experiences a net
reserve drain. Under the assumed 10 percent reserve requirement, a given amount of bank reserves can
support deposits ten times as great, but when drawn upon to meet currency demand, the exchange is
one to one.

After holiday periods, currency returns to the banks. The customer who cashed a check to cover
anticipated cash expenditures may later redeposit any currency still held that’s beyond normal pocket
money needs. Most of it probably will have changed hands, and it will be deposited by operators of
motels, gasoline stations, restaurants, and retail stores. This process is exactly the reverse of the
currency drain, except that the banks to which currency is returned may not be the same banks that
paid it out. But in the aggregate, the banks gain reserves as 100 percent reserve money is converted
back into fractional reserve money.

To avoid multiple contraction or expansion of deposit money merely because the public wishes
to change the composition of its money holdings, the effects of changes in the public's currency holdings
on bank reserves normally are offset by System open market operations.

MONEY SUPPLY

The money supply (also called money stock) is the entire stock of currency and other liquid
instruments circulating in a country's economy as of a particular time. The money supply can include
cash, coins, and balances held in checking and savings accounts, and other near money substitutes.
Economists analyze the money supply as a key variable to understanding the macro economy and
guiding macroeconomic policy.

Macroeconomics is a branch of economics that studies how an overall economy—the market systems
that operate on a large scale—behaves. Macroeconomics studies economy-wide phenomena such as
inflation, price levels, rate of economic growth, national income, gross domestic product (GDP), and
changes in unemployment.

A liquid asset is an asset that can easily be converted into cash within a short amount of time.
Liquid assets include things like cash, money market instruments, and marketable securities.

Understanding Money Supply

Economists analyze the money supply and develop policies revolving around it through
controlling interest rates and increasing or decreasing the amount of money flowing in the economy.
Public and private sector analysis is performed because of the money supply's possible impacts on price
level, inflation, and the business cycle. In the United States, the Federal Reserve policy is the most
important deciding factor in the money supply.

Effect of Money Supply on the Economy

An increase in the supply of money typically lowers interest rates, which in turn, generates more
investment and puts more money in the hands of consumers, thereby stimulating spending. Businesses
respond by ordering more raw materials and increasing production. The increased business activity
raises the demand for labor. The opposite can occur if the money supply falls or when its growth rate
declines.

Historically, measuring the money supply has shown that relationships exist between it and inflation and
price levels. However, since 2000, these relationships have become unstable, reducing their reliability as
a guide for monetary policy. Although money supply measures are still widely used, they are one of a
wide array of economic data that economists and the Federal Reserve collects and reviews.

How Money Supply is Measured

The various types of money in the money supply are generally classified as Ms, such as M0, M1,
M2 and M3, according to the type and size of the account in which the instrument is kept.

Not all of the classifications are widely used, and each country may use different classifications.
The money supply reflects the different types of liquidity each type of money has in the economy.

It is broken up into different categories of liquidity or spendability.

M0 and M1- narrow money and include coins and notes that are in circulation and other money
equivalents that can be converted easily to cash.

M2- includes M1 and, in addition, short-term time deposits in banks and certain money market funds.
M3 - includes M2 in addition to long-term deposits, larger deposit.

Money supply data is collected, recorded and published periodically, typically by the country's
government or central bank.

VELOCITY OF MONEY

• It is the average frequency of monetary transactions with which a unit of money is spent in an
economy.

• It is the connection between money as a stock and money in circulation.

Understanding Velocity of Money

For example, assume a very small economy that has a money supply of $100 and only two
people. Bob sells pencils and Jane sells paper. Bob starts with the $100 and buys $100 worth of paper
from Jane. Jane turns around and buys $100 worth of pencils from Bob. Bob and Jane's economy now
has a "gross domestic product" of $200 even though the money supply is only $100. If Bob and Jane do
the same two transactions every month, their "GDP" will be $2,400 per year, though the money supply
is only $100.
The equation for GDP is: GDP = Money Supply x Velocity of Money.

To solve for velocity in our example, we rearrange the equation to get Velocity = GDP / Money Supply,
or ($2,400 / $100). Velocity of money in our two person economy is 24.

The velocity of money collapsed during the Great Depression of the 1930s. The long period of
the increase of the velocity lasted from the late 1940s until 1980 before the trend turned downwards
again. An even steeper decline of the velocity took place since the outbreak of the financial crisis in
2008.

The downturn in the 1980s occurred after the Federal Reserve (FED) had introduced its new
monetary policy. It turned out that the measures taken were more restrictive than intended. The
policymakers at the central bank presumed that the decades-long trend would continue. The U.S.
interest rate rose, and the American economy plunged into a recession that dragged many of the
indebted developing countries into insolvency. The deceptive relationship between the money supply
and the nominal gross domestic product over the decades before 1980 induced the FED to implant a
more restrictive monetary policy than was the intent.

A country’s central bank has the tools to control the monetary base, but it cannot determine
how and to which degree the central bank’s money enters the economy and whether the contractive or
expansionary intention of the central bank will be strengthened or aborted by the individual economic
actors’ use of the money.

The most recent example of such a policy failure is the concept of the so-called ‘quantitative
easing’. The contraction of the velocity of circulation of money explains why the massive increase of the
monetary base by the American central bank has not led to a price inflation.

Quantitative Easing – This involves the Central Bank increasing the money supply and using these
electronically created funds to buy government bonds or other securities. It is a form of expansionary
monetary policy that usually used in a liquidity trap – when base interest rates cannot be cut any
further.

Therefore, the aim of quantitative easing is to increase bank lending to higher investment that
should stimulate economic growth and increase inflation because it is seen as a solution to deflation.
During deflation (falling prices), there is a reduction in consumer spending often causing a recession.
Quantitative easing can help increase inflation closer to the government’s inflation target of 2%.

Why Velocity of Money matter

Velocity of money is an incredibly important component of an economy's GDP calculation.

As the equation illustrates, GDP cannot be controlled through money supply alone. If money
supply is increased, but velocity decreases, GDP may stay the same or even decline. If money supply is
decreased but velocity increases, GDP could increase. Velocity is much more difficult to control than
money supply, so be wary of macroeconomic analysis that equates an increase in money supply with an
increase in GDP and/or inflation (and vice versa) without taking velocity of money into consideration
 It can strengthen or weaken the effects of a change of the amount of money.

The countermovement of the velocity can change an increase of the stock of money into a
contraction or turn a monetary contraction of the stock into an expansion. Inflationary expectations lead
to a higher ratio of the velocity of money while deflationary and dis-inflationary expectations lead to a
lower ratio of the velocity.

The frequency of the monetary transactions depends on the decisions of the individual users of
money in the economy.

When people decide to use money more rapidly, the velocity rises, and this would accelerate
the effect of the expansion of the monetary stock. When, in contrast, the public uses available money
more slowly, the velocity falls. Such actions would offset the effect of the expansion of the stock of
money, or, in the case of a reduction of the stock of money, accelerate the contraction.

The velocity of the circulation of money is subject to strong swings.

Because the ratio is not stable, the effects of changes in the money supply are not certain.
There are no tools to control the velocity. The monetary authorities are not able to foresee how the
velocity of money will change. The trends may be long or short, and when they are long and seem to be
stable, they may change abruptly. A reliable calculation of the future trend is not possible even if many
data points are available.

Video Link:

https://youtu.be/FZb1JQ8_-oo

News Item:

https://www.philstar.com/business/2018/11/01/1864814/money-supply-expansion-slows-september-
2018

Thesis:

https://www.google.com/url?sa=t&source=web&rct=j&url=http://www.ide.go.jp/library/English/Publis
h/Download/Dp/pdf/413.pdf&ved=2ahUKEwi0vOSsy7DkAhUWFYgKHWwsAqkQFjAMegQIBBAB&usg=A
OvVaw27axoWb3sTvrp3-OnuFM_2&cshid=1567374454059
Sources:

Chen, James. (2019) Investopedia. Dotdash Pubilishing. Retrieved at

https://www.investopedia.com/terms/d/deposit_multiplier.asp

Investing Answers, Inc. https://www.google.com/amp/s/investinganswers.com/dictionary/v/velocity-

money

Mueller, Anthony. (2018) American Institute for Economic Research. AIER. Retrieved at
https://www.aier.org/article/what-money-velocity-and-why-does-it-matter

Spaulding William C. This Matter. Retrieved at

https://www.google.com/amp/s/thismatter.com/money/banking/money-supply-money-
multiplier.amp.htm

https://l.facebook.com/l.php?u=https%3A%2F%2Fwww.investopedia.com%2Fterms%2Fm%2Fm3.asp%
3Ffbclid%3DIwAR2gYPib_28viacZLoPBKi2rlOLNzAHPef7d3bQvpeR3dat-
7TIFzaHi1Uk&h=AT3HhViyHngzcx-iezoO7AYyx9mkLBjSSfnoJSY-
2GPyq8A23ZOLKc2jIElq4bGGCfWmpimk6tKZjH3DdOfv0Z9F6znns8MauQIJ4yiVHhorSXsnPPn2q2isYP6DM
zeGYTKC

https://www.investopedia.com/terms/m/m3.asp

http://www.businessdictionary.com/definition/checkable-deposits.html

http://www.bsp.gov.ph/publications/media.asp?id=5024

http://www.bsp.gov.ph/financial/open.asp

https://www.investopedia.com/terms/m/moneysupply.asp

https://www.investopedia.com/terms/f/fractionalreservebanking.asp

https://www.google.com/search?client=ms-android-samsung&ei=crhfXb-
ZHtPrwQOfsILQCg&q=what+is+safeguard+in+banking+system&oq=what+is+safeguard+in+bank&gs_l=m
obile-gws-wiz-
serp.1.1.33i160l2.2105.4253..6143...0.1..1.430.1964.0j4j2j0j2....2..0....1.........0i71j0j0i20i263j0i22i30j0i7
0i255j33i22i29i30.D0YFBKlmzhk

https://www.google.com/search?client=ms-android-samsung&ei=crhfXb-
ZHtPrwQOfsILQCg&q=what+is+safeguard+in+banking+system&oq=what+is+safeguard+in+bank&gs_l=m
obile-gws-wiz-
serp.1.1.33i160l2.2105.4253..6143...0.1..1.430.1964.0j4j2j0j2....2..0....1.........0i71j0j0i20i263j0i22i30j0i7
0i255j33i22i29i30.D0YFBKlmzhk