Name: JOJIE A.

DADOR Course & Year: BSBA 3rd Year

Subject: Finance 4 – Monetary Policy & Central

ASSESSMENT FOR BANGKO SENTRAL AND MONETARY POLICY

I. True or False

False 1. The Financial system channels funds from the deficit units to the savings units.

True 2. The financial system provides a medium of exchange.

False 3. Households are families which do not include single individuals in terms of the

financial system.

True 4. The powers and functions of BSP are exercised by its Monetary Board.

True 5. Under the New Central Bank Act, one of the government sector members of the

monetary Board must also be a member of the cabinet designated by the President.

False 6. To attain its objectives, only the monetary policies of the country need to be closely
monitored and discharged.

False 7. Increases in the money supply push short-term interest rates up, encouraging investment
and consumption.

True 8. An Abundance of money supply leads to increased prices or inflation.

True 9. BSP may lower interest rates and stimulate investment and consumption in the short run.

False 10. When BSP sells securities, it increases money supply in the economy.

True 11. When BSP increases the reserve requirement for banks, it reduces the amount available
to banks for lending to borrowers, thus limiting the credit and ultimately the money supply.

False 12. Increases in the money supply push interest rates up, which stimulates demand.

II. Identification
1. The Philippine Central Bank
Ans: Bangko Sentral Ng Pilipinas (BSP)

2. Firms that bridge the gap between the surplus units and the deficit units.
Ans: Financial Intermediaries/Institutions

3. Equal to current income less current expenditures.

Ans: Gross Savings

4. Another word for expenditures.

 Ans: Spending

5. Goods consumed within current period.

Ans: Non-durable consumer goods
6. The participants from the rest of the world- households, governments, financial and non-
financial firms, and the central banks.
Ans: Foreign Participants

7. The body that governs the Central Bank

Ans: Monetary Board

8. The BSP sector that enforces and monitors compliance to banking laws to promote a sound
and healthy banking system.
Ans: Financial Supervision Sector (previously known as Supervision and Examination
Sector)

9. Refers to the manipulation of the money supply to affect the economy of the country as a
whole.
Ans: Monetary Policy

10. Loans granted by banks with excess reserves to banks with deficit reserves.
Ans: Interbank Loans

11. The BSP sector that takes charge of the formulation and implementation of the BSP's
monetary policy, including serving the banking needs of all banks through accepting
deposits, servicing withdrawals, and extending credit through the discounting facility.
Ans: Monetary and Economics Sector (previously known as Monetary Stability Sector)

12. The independent Central Monetary Authority in the Philippines.

Ans: Bangko Sentral Ng Pilipinas (BSP)

13. The BSP sector that serves the Human, financial and physical resource needs of BSP.
Ans: Corporate Services Sector (previously known as Resource Management Sector)

14. Refers to regulations that will affect money supply to benefit the economy.
Ans: Monetary Policy

15. Firms that act as the bridge between surplus us/lenders and deficit units/borrowers.
Ans: Financial Intermediaries/Institutions

16. Wage /salary earners whose income is spent on goods and services.
Ans: Household

III. Enumeration

1-5 Objectives of BSP

1.) Maintain monetary policies conducive to balanced and sustainable growth of the economy.
 2.) Maintain price stability in the country.
3.) Promote and maintain monetary stability and convertibility of the peso.
4.) Maintain stability of the financial system.
5.) Supervise and regulate depository institutions.

6-12 Function of BSP

6.) Liquidity Management

7.) Currency Issue
8.) Lender of Last Resort
9.) Financial Supervision
10.) Management of Foreign Currency Reserves
11.) Determination of Exchange Rate Policy
12.) Being the banker, financial advisor, and official depository of the government, its political
subdivisions and instrumentalities, and GOCCs

13-15 Tools use by BSP to control credit

13.) Rediscounting
14.) Overdraft Credit Line (OCL)
15.) Emergency Loan

16-20 Major functions of the Monetary Board

16.) Issue rules and regulations

17.) Direct the management, operations, and administration of the BSP
18.) Establish a human resource management which shall govern the selection, hiring,
appointment, transfer, promotion, or dismissal of all personnel
19.) 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.
20.) 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

MONETARY POLICY

1. Manuel bought a bond last year for $10,000 that promises to pay him $900 a year. He can buy a
bond for $10,000 that promises to pay $1,000 a year. If Manuel wants to sell his old bond, what
is its price likely to be?
Ans: Interest Rate for Previous Year is 9% ($900/$10,000)
Interest Rate for Current Year is 10% ($1,000/$10,000)
Since the interest rate in the current year is higher than last year, Manuel has to lower
the price of his bond below the bonds that offer a higher rate of interest. Thus, Manuel
should sell his bond at $9,000 ($900/10%).
 2. Charu bought a bond last year for $10,000 that promises to pay her $1,000 a year. This year,
investors can buy a bond for $10,000 that promises to pay $800 a year. If Charu wants to sell her
old bond, what is its price likely to be?
Ans: Interest Rate Last Year is 10% ($1,000/$10,000)
Interest Rate for Present Year is 8% ($800/$10,000)
Since the interest rate of the previous year is higher than that of current year, Charu
should sell her bond at a higher price than the bonds with a lower interest rate. Thus, Charu should
sell her bond at $12,500 ($1,000/8%).

3. The annual average percentage change in Real GDP is 2.3 % , and the annual average percentage
change in velocity is 1.1 % . Using the monetary rule discussed in the text, what percentage
change in the money supply will keep prices stable ( on average)?
Ans: %ΔM = %ΔP + %ΔQ - %ΔV
= 0 + 2.3% - 1.1%
= 1.2 %
4. Graphically show that the more interest insensitive the investment demand curve is, the less
likely it is that monetary policy will be effective at changing Real GDP.

Interest Rate S1 S2

This figure shows the effect of an

i1 Expansionary Monetary Policy. It shifts
the money supply to the right. The
equilibrium quantity of money increases
i2 while the interest rate falls.

D1

0 M1 M2
Quantity of Money

Interest Rate

The second figure shows that a fall in

i1
the interest rate increases the
investment level in the investment
i2 ‘ goods market. The increase in the
investment demand is more when it is
Inv.Demand1 less interest insensitive.
Inv.Demand2

0 I I2 I1 Investment
Interest Rate
AD AD2 AD1 It can be shown in the graph that the
shift in the aggregate demand curve is
more when the investment demand
curve is less interest insensitive. That
i1
being said, the real GDP will increase
AS more when the investment demand is
i2
less interest insensitive.

Thus, monetary policy is less effective in

changing the real GDP when there is
0 Q Q2 Q1 interest-insensitive investment demand.
Real GDP

5. Graphically portray the ff:

a. Expansionary monetary policy that c. Contractionary monetary policy that

effectively removed the economy effectively removes the economy
from a recessionary gap. from an inflationary gap.

b. Expansionary monetary policy that

is destabilizing d. Monetary policy that is ineffective
at changing Real GDP.
 6. Graphically portray the Keynesian transmission mechanism under the following conditions:

a. A decrease in the monetary b. No liquidity trap

supply

Interest Rate S2 S1 Interest Rate

i2 i2

i1 i1

D1 I

0 M2 M1 0 I2 I1
Quantity of Money Investment

c. Downward-sloping investment demand.

Price Level
AS1

A B
P

AD1
AD2

0 Q2 Q1 QN Real GDP

7. Graphically portray the Monetarist transmission mechanism when the money supply declines.

Interest Rate S2 S1

This diagram shows the decline in

money supply in the economy.
I1

D1
0 M2 M1
Quantity of Money
 Graph 1

SRAS This diagram shows the change in

Price Level

real GDP due to a shift in

Aggregate Demand.

When the money supply in the economy decreases

from M1 to M2, the money supply curve shifts from
AD1 S1 to S2 (refer to Graph 1). The decrease in the supply of
AD2
money results in the decline in money, which
0 Q2 Q1 Real GDP further reduces the aggregate demand of the
Graph 2 economy from AD1 to AD2. The real GDP decreases
from Q1 to Q2 (refer to Graph 2).

8. According to the Taylor rule. If inflation is 8% and the GDP gap is 3%. What is the
recommendation for the federal funds rate target?
Ans: Federal Fund Rate Target = 1.5 x (rate of inflation) + 0.5 x (GDP gap) +1
= 1.5 x (8%) + 0.5 x (3%) + 1
= 12% + 1.5% + 1
= 14.5%
9. Draw both the money market and bond market in equilibrium. Next explain and
diagrammatically show what happens to the interest rate and the price of bonds as a result of
the BSP increasing the money supply.

Interest Rate S1

0 Quantity of Bonds

S1 S2
A Money Market
Interest Rate

A
B
D1

0 C
Quantity of Money

D1 D1
S1
Price of Bonds 0 Quantity of Money

D1 D2 S1
A Bond Market

C
 Price of Bonds

B
A

0 Quantity of Bonds

The money market and the bond market are in equilibrium at point A with the given
interest rate and price. With the increase in supply of money, more bonds are demanded, hence
the price falls and interest rate rises. That being said, there is a shortage in the bond market.

10. Draw both the money market and bond market in equilibrium. Next, explain and
diagrammatically show what happens to the interest rate and the price of bonds as a result of
BSP decreasing the money supply.
D1
S1 Interest Rate S1
Interest Rate

B A

A
C

D1
D1
0 Quantity of Money
0 Quantity of Money
Money Market
Price of Bonds
Money Market D1
D2 S1
Price of Bonds

A
A
C
B

0 Quantity of Bonds

Bond
S2 Market
S1 0 Quantity of Bonds

Money Market

With the decrease in supply of money, fewer bonds are demanded. As a result, there is a
surplus in the bond market and a shortage of money.
11. Identify the state of the bonds market equilibrium, shortage, surplus, given each of the
following:

Shortage in the money market- a shortage in the money market implies a surplus in the bond
market. People would reduce the bond holdings because there would be a shortage of supply of
money and so, the demand for the bond will fall. Eventually, causes a surplus of bond.

Surplus in the money market- refers to a shortage in the bond market. People start buying
more and more bonds because there is an excess supply of money and as a result, the demand for
bond rises and given the price of the bonds, there will be a shortage of bonds.

Equilibrium in the money market- the bond market is said to be in equilibrium if there is
equilibrium in the money market.

12. Consider the following: Two researchers, A and B, are trying to determine whether eating fatty
foods leads to heart attacks. The researchers proceed differently. Researcher A builds a model in
which fatty foods may first affect X in one's body. And if X is affected, then Y may be affected,
and if Y is affected, then Z may be affected, finally, if Z is affected, the heart is affected, and the
individual has an increased probability of suffering a heart attack. Researcher B doesn't proceed
in this step by step fashion. She conducted an experiment to see whether people who eat many
fatty foods have more, fewer, or the same number of heart attacks as people who eat few fatty
foods. Which researcher's methods have more in common with the research methodology
implicit in the monetarist transmission mechanism? Explain your answer.
Ans: Researcher A’s methodology establishes an indirect link between consuming fatty
food and heart health. So Researcher A’s method is the similar to the Keynesian
transmission mechanism with an indirect relationship between the money market and
the goods and services market. Whereas, Researcher B’s method is direct and links
consuming fatty food and heart health directly. As a result, it reflects the monetary
transmission mechanism which believes in a direct link between the money market and
the goods and services market.

13. If bond prices fall, will individuals want to hold more or less money? Explain your answer.

Ans: Individuals would want to hold less money as the bond prices have an inverse
relationship with interest rates. That is, if bond prices fall, the rate of interest rises and vice-
versa. Higher interest rates would increase the opportunity cost of holding money. As a result,
people would hold less money and deposit the money in banks to earn a higher interest.

14. Why is the demand curve for money downward sloping?

Ans: When the interest rates increases, individuals no longer want to hold money in the
form of cash and wish it to invest to earn higher interest rates. As a result, the quantity
demanded for money falls. On the other hand, when the interest rates declines, more people
would prefer to hold money as the reward for savings is less or lesser. To be specific, lower
interest rates increase the quantity demanded of money. This explains why demand curve for
money is downward sloping as money and interest rate has inverse relationship.

15. Explain how it is possible to have too much money.

 Ans: Surplus or too much money would refer to a situation where the quantity supplied
of money exceeds its quantity demanded, or people have too much money for other
goods/services. Let’s say, when the interest rate rises, the equilibrium quantity and the supply of
money increase more than the demand for money. Under this situation, it is possible to have too
much money. Another example would be, if a person can either hold money or buy bonds.
Instead of buying bonds, if the surplus money is held, it could be called too much money.

16. Explain how the Keynesian transmission mechanism works.

Ans: The Keynesian transmission establishes an indirect relationship between the money
market and the goods and services market. An increase in the money supply, affects the
aggregate demand indirectly.

For instance, the central bank increases the reserved ratio from 20% to 25% and sells
securities to banks, the supply of loans decreases. When the money supply decreases, interest
rate rise, and in turn increases the cost of borrowing and decreases investments. Consequently,
the aggregate demand declines and unemployment rises. The reverse happens when the supply
of money increases. Let’s say, the central bank increases the money supply through decreasing
the bank reserve ratio and purchasing securities from banks. When money supply increases, it
pushes interest rates downwards which encourage investments. A rise in investment increases
aggregate demand and increases real GDP and decreases unemployment rate. Thus, changes in
money supply inversely impacted the aggregate demand through interest rates and investment.

17. Explain how the monetarist transmission mechanism works.

Ans: The monetarist market mechanism establishes a direct link between the money
market and the goods and services market. The increase in the money supply increases the
amount of money that individuals hold, which increases the consumption expenditure, thereby
increasing the real GDP. However, a fall in the money supply reduces the excess supply of money,
which decreases consumption; thus, reduces the aggregate demand for goods and services.