THE MONETARY SYSTEM

OBJECTIVES:
1. To define and analyze the concept of money, its types and uses;
2. To investigate the monetary systems
3. To explain exchange rates and their significance in international trade and finance; and
4. To understand the role of the International Monetary Fund and Bangko Sentral ng Pilipinas in
monetary systems

MONEY
Money is the set of assets in the economy that people regularly use to buy goods and services from
each other. The cash in your wallet is money because you can use it to buy a meal at a restaurant or a
shirt at a clothing store. By contrast, if you happened to own a large share of Microsoft Corporation, as
Bill Gates does, you would be wealthy, but this asset is not considered a form of money. You could not
buy a meal or a shirt with this without first obtaining some cash. According to the economist’s
definition, money includes those only few types of wealth that are regularly accepted by sellers in
exchange for goods and services.

HISTORY OF MONEY
The history of money is a story of innovation and adaptation, beginning with primitive barter systems
where goods and services were exchanged directly, leading to the emergence of commodity money,
such as shells and precious metals, valued for their intrinsic worth. Ancient civilizations formalized this
system with standardized metallic coins, enabling more efficient trade. Paper money made its debut in
China during the Tang Dynasty, evolving into banknotes in medieval Europe, backed by the promise of
redemption for precious metals. The modern era witnessed the rise of fiat currency, detached from
physical assets and reliant on government decree, facilitating economic stability and growth. Electronic
money emerged with technological advancements, allowing for digital transactions via cards and online
banking, while crypto currencies like Bit coin introduced decentralized digital currencies, revolutionizing
the concept of money and decentralizing control over monetary systems. Throughout this journey,
money has adapted to meet the evolving needs of societies, serving as a medium of exchange, unit of
account, and store of value.

FUNCTIONS OF MONEY
1. Medium of exchange
2. Store of value
3. A unit of account/ standard of value
4. Standard of deferred payment
5. Guarantee of solvency
 6. An object of gifts

1. A medium of exchange is an item that buyers give to sellers when they purchase goods and
services. When you buy a shirt at a clothing store, the store gives you the shirt, and you give the store
your money. This transfer of money from buyer to seller allows the transaction to take place.

2. Store of value is an item that people can use to transfer purchasing power from the present to
the future. When a seller accepts money today in exchange for a good or service, that seller can hold the
money and become a buyer of another good or service at another time. Money may not even be the
best store of value because it depreciates with inflation. However, money is more liquid than most other
stores of value because as a medium of exchange, it is readily accepted everywhere. Furthermore,
money is an easily transported store of value that is available in a number of convenient denominations.

3. Money also functions as a unit of account, providing a common measure of the value of goods
and services being exchanged. Knowing the value or price of a good, in terms of money, enables both
the supplier and the purchaser of the good to make decisions about how much of the good to supply
and how much of the good to purchase.

KINDS OF MONEY

There are several kinds of money varying in liability and strength. The society has modified the money at
different times and in this way several types of money are introduced. When there was ample
availability of metals, metal money came into existence later it was substituted by the paper money. At
different times, several commodities were used as the medium of exchange. So, it can be said that
according to the needs and availability of means, the kinds of money has changed.

There are 4 major types of money:

1. Commodity Money
2. Fiat Money
3. Fiduciary Money
4. Commercial Bank Money
5. Token Money
6. Paper Money

1. Commodity Money

It is the simplest kind of money which is used in barter system where the valuable resources
fulfill the functions of money. The value of this kind of money comes from the value of resource used for
the purpose. It is only limited by the scarcity of the resources. Value of this kind of money involves the
parties associated with the exchange process. This money has intrinsic value.

Example: gold coins, beads, shells, pearls, stones, tea, sugar, metal
 2. Fiat Money

The word fiat means the “command of the sovereign”. Fiat currency is the kind of money which
doesn’t have any intrinsic value and it can’t convert into a valuable resource. The value of fiat money is
determined by government order which makes it a legal instrument for all transaction purposes. The fiat
money needs to be controlled as it may affect entire economy of a country if it is misused. Today Fiat
money is the basis of all the modern money system.

Example: Paper money, coins.

3. Fiduciary Money

Today’s monetary system is highly fiduciary. Whenever any bank assures the customers to pay
in different types of money and when the customer can sell the promise or transfer it to somebody else,
it is called the fiduciary money. There are checks and banknotes, which are the examples of fiduciary
money because both are some kind of token which are used as money and carry the same value.

Example: Checks and banknotes

4. Commercial Bank Money

Commercial Bank money or demand deposits are claims against financial institutions that can be
used for the purchase of goods and services. A demand deposit account is an account from which funds
can be withdrawn at any time by check or cash withdrawal without giving the bank or financial
institution any prior notice. Banks have the legal obligation to return funds held in demand deposits
immediately upon demand. Demand deposit withdrawals can be performed in person, via checks or
bank drafts, using automatic teller machines (ATMs), or through online banking.

Primary characteristics of money

Money has several key characteristics that make it effective as a medium of exchange and store of value.
These characteristics are necessary for financial and economic systems to run smoothly

Portability: This signifies the ease with which money can be transported. Physical currencies should be
convenient to carry, while digital forms of money, such as electronic transfers and mobile payments,
exemplify the heightened portability that characterizes modern financial systems.

Divisibility: Money is said to be divisible if it can be split up into smaller amounts without losing value.
This characteristic ensures that money can adapt to various transaction sizes. For example, a currency
must be simple to divide for both small-scale transactions like buying coffee and larger ones like buying
real estate.

Uniformity: In terms of quality and worth, every unit of currency should be the same no matter where
or when it was produced. This consistency helps to avoid misunderstandings and disagreements during
transactions.

Acceptability: The more widely accepted money is, the more useful it is for enabling transactions. Legal
tender rules frequently play a role in the general acceptance of a particular currency within a given
jurisdiction.
Recognizability: Each piece of money must be recognizable to be easily distinguished from counterfeits.
Money is made more recognizable by security measures, unique designs, and symbols.

Durability: Physical forms of money, such as coins and banknotes, need to be resilient to ensure that
they remain in circulation and retain their functionality. Durable money reduces the frequency of
replacements and maintains its integrity, contributing to the stability of the monetary system.

Store of Value: The degree to which money’s purchasing power is steady throughout time is reflected in
its stability of value. Although some inflation is normal, too much volatility might damage people’s trust
in the currency. Monetary policies are used by central banks to control inflation and maintain the value
of money.

Elasticity of Supply

MONETARY SYSTEM
Monetary System is a set of policies, frameworks, and institutions by which the government create,
circulate, and regulate money in an economy.
The government uses the monetary system to maintain the value of a domestic currency in foreign
markets through interest rates, spending policies, and tax measures. It is also used in controlling
inflation and deflation.

THREE COMMON TYPES OF MONETARY SYSTEMS

1. Commodity Money
2. Commodity-based Money
3. Fiat Money
EXCHANGE RATE
The exchange rate is the price of a unit of foreign currency in terms of the domestic currency. In every
exchange rate quotation, therefore, there are always two currencies involved.
Example: US$1 = P50.00.

Why is the exchange rate important?

The exchange rate is important for several reasons:

• It serves as the basic link between the local and the overseas market for various goods,
services and financial assets. Using the exchange rate, we are able to compare prices of goods,
services, and assets quoted in different currencies.
• Exchange rate movements can affect actual inflation as well as expectations about future price
movements. Changes in the exchange rate tend to directly affect domestic prices of imported
 goods and services. A stronger peso lowers the peso prices of imported goods as well as
import‐intensive services such as transport, thereby lowering the rate of inflation.
• Exchange rate movements can affect the country’s external sector through its impact on
foreign trade. An appreciation of the peso, for instance, could lower the price competitiveness
of our exports versus the products of those competitor countries whose currencies have not
changed in value.
• The exchange rate affects the cost of servicing (principal and interest payments) on the
country’s foreign debt. A peso appreciation reduces the amount of pesos needed to buy
foreign exchange to pay interest and maturing obligations.

INTERNATIONAL MONETARY FUND

The International Monetary Fund (IMF) works to achieve sustainable growth and prosperity for all of its
190 member countries. It does so by supporting economic policies that promote financial stability and
monetary cooperation, which are essential to increase productivity, job creation, and economic well-
being. The IMF is governed by and accountable to its member countries.

When was the IMF founded?

The IMF was conceived in July 1944 at the United Nations Bretton Woods Conference. The 44 countries
in attendance sought to build a framework for international economic cooperation and avoid repeating
the competitive currency devaluations that contributed to the Great Depression of the 1930s.

Who runs the IMF?

The IMF is accountable to its member country governments. At the top of the organizational structure is
the Board of Governors, consisting of one governor and one alternate governor from each member
country, usually the top officials from the central bank or finance ministry. The Board of Governors
meets once a year at the IMF–World Bank Annual Meetings. Twenty-four of the governors serve on the
International Monetary and Financial Committee, or IMFC, which advises the IMF’s Executive Board.

The day-to-day work of the IMF is overseen by its 24-member Executive Board, which represents the
entire membership and is supported by IMF staff. The Managing Director is the head of the IMF staff and
Chair of the Executive Board and is assisted by four Deputy Managing Directors.

The IMF has three critical missions: furthering international monetary cooperation, encouraging the
expansion of trade and economic growth, and discouraging policies that would harm prosperity. To fulfill
these missions, IMF member countries work collaboratively with each other and with other
international bodies.

What does the IMF do?

The IMF fosters international financial stability by offering:

1. POLICY ADVICE
2. FINANCIAL ASSISTANCE
 3. CAPACITY DEVELOPMENT

What kind of financial assistance does the IMF offer?

Providing loans and concessional financial assistance to member countries experiencing actual or
potential balance-of-payments problems is a core responsibility of the IMF.

What other assistance does the IMF offer?

The IMF provides capacity development, which is technical assistance and training of government
officials to help member countries strengthen economic institutions and statistics, as well as capacities
in areas such as taxation and administration, expenditure management, monetary and exchange rate
policies, financial system supervision and regulation, and legislative frameworks.

BANGKO SENTRAL NG PILIPINAS

The Bangko Sentral ng Pilipinas (BSP), as the central bank of the Philippines, plays a crucial role in the
country's monetary system. Its responsibilities encompass formulating and implementing monetary
policy, issuing currency, regulating financial institutions, and maintaining economic stability.

The Role of BSP in the Monetary System of the Philippines:

1. Monetary Policy Formulation and Implementation

The BSP is tasked with formulating and implementing monetary policies aimed at achieving price
stability conducive to sustainable economic growth. It utilizes various monetary policy tools such as
open market operations, reserve requirements, and the setting of key interest rates (e.g., overnight
borrowing and lending rates) to manage the money supply and influence economic activity.

2. Currency Issuance and Management

As the sole issuer of currency in the Philippines, the BSP is responsible for the production,
distribution, and regulation of banknotes and coins. It ensures the integrity and security of the currency,
as well as the availability of adequate cash supply to meet the demands of the economy. The BSP also
oversees the demonetization and replacement of old or damaged banknotes and coins to maintain the
quality and efficiency of the currency circulation system.

3. Regulation and Supervision of Financial Institutions

The BSP serves as the regulatory authority for banks and non-bank financial institutions
operating in the Philippines. It formulates and implements regulations and supervisory policies to ensure
the stability, integrity, and efficiency of the financial system. Through prudential regulations,
supervision, and oversight activities, the BSP promotes sound banking practices, risk management, and
financial inclusion while safeguarding the interests of depositors and investors.

4. Economic and Financial Stability Maintenance

One of the primary objectives of the BSP is to maintain economic and financial stability in the
Philippines. It monitors domestic and external developments, assesses risks to the economy and
financial system, and takes preemptive and corrective measures as necessary to mitigate vulnerabilities.
The BSP also collaborates with other government agencies and international institutions to address
systemic risks, financial crises, and other challenges that may arise in the Philippine economy.

5. International Engagement and Cooperation

The BSP represents the Philippines in various international forums and engages in international
cooperation and collaboration on monetary, financial, and banking matters. It participates in initiatives
led by organizations such as the International Monetary Fund (IMF), World Bank, Asian Development
Bank (ADB), and Association of Southeast Asian Nations (ASEAN) to promote regional and global
economic stability and development.