MACROECONOMICS

Macroeconomic Accounting
Money Supply
Classical Growth model: IS-LM model

Angelo Gabrielle F. Santos

OUTLINE
A. Macroeconomic Accounting
What are the different measures of
economic performance?
What are the components of the
Balance of Payment (BOP) account?
When does the BOP surplus/deficit
arise?

Angelo Gabrielle F. Santos

Macroeconomic Accounting
Y C I G NX
OR:
Wherein:
Y = Gross Domestic Product
NX = Net exports

Note: CA = NX + net unilateral

transfers

Angelo Gabrielle F. Santos

Difference between GDP and

GNP
GNP is a measure of economic
activity by every citizen of a country,
regardless of location; while GDP is a
measure by location.
E.g. GNP- output produced by every
Filipino around the world; GDP- output
produced in the Philippines including
those of foreigners.

Angelo Gabrielle F. Santos

Different measures of economic

activity
1. Net National Product (NNP):
= GNP depreciation
2. National Income:
= NNP indirect business taxes
3. Personal Income (PI):
= NI income earned but not received
+ income received but not earned
4. Private Disposable Income (Y-T) or (Yd)
= PI personal taxes
Angelo Gabrielle F. Santos

Macroeconomic Accounting
Balance of Payment (BOP)
BOP CA KA FA 0
Accounts
Where:
CA = Current Account
KA = Capital Account
FA= Financial Account

Angelo Gabrielle F. Santos

Current Account (CA)

Includes (X-M) goods and services,
and unilateral transfers.
Exports and inward remittances are
positive entries in the BOP sheet.
Example: OFW sends money to
relatives in the Philippines. This is
recorded as a positive entry in the
balance sheet.
Angelo Gabrielle F. Santos

Current Account
Derivation
Y C I G CA
(Y T) C I T G CA
Sp I Sg CA
Sn I CA
Wherein:
T= taxes
Sp= household savings
Sg= government savings
Sn= national savings
Angelo Gabrielle F. Santos

Financial Account (FA)

E.g., portfolio investments, foreign
direct investments, paper assets, etc
Inflows of these instruments are
recorded as positive entries in the
balance sheet.
Example: A Japanese corporation buys
treasury bonds in the Philippines. This is
a positive entry for the Philippines
balance sheet, while it is a negative
entry for Japans balance sheet.
Angelo Gabrielle F. Santos

BOP Surplus or Deficit

BOP 0 CA FA KA
KA 0
CA (FA)
CA (FA( pvt) FA(official)
CAFA( pvt) FA(official)

Wherein FA(official) is the official

reserve
settlement balance.
Angelo Gabrielle F. Santos

BOP Surplus or Deficit

FA (official) is negative
(positive) in order to offset the
change in CA and/or FA (private).
I.e., if CA + FA (private) > 0, then
FA (official) is negative (positive),
and there is a BOP surplus
(deficit).
For deficit (surplus) to clear out,
the Central Bank has to sell
(buy) currency at the Foreign
Angelo Gabrielle F. Santos

OUTLINE
B. Money Supply
What are the functions of money?
How did money evolve?
What are the classification of monetary
aggregates?
What are the components of the central
banks and the banking systems balance
sheets.
What are the quantitative tools of
monetary policy?
Angelo Gabrielle F. Santos

Functions of Money
1. Medium of Exchange
Suppose: a barter economy with n
commodities. Then, there n(n1)
are
2
set of prices due to the problem of
double coincidence of wants.
2. Unit of Account- prices in terms of
money rather than other goods.
3. Store of Value- money used to
purchase future goods by foregoing
current purchases.
Angelo Gabrielle F. Santos

Evolution of Money
1. Commodity money
E.g., gold, cigarettes in POW camps (see
Radford,1945)*

2. Fiat money- Faith that a paper bill, with

almost no intrinsic value is recognized by
law.
E.g. paper bills, coins

3. E-money
E.g., Globe G-cash, Paypal, credit card payments

Angelo Gabrielle F. Santos

Monetary Aggregates

Angelo Gabrielle F. Santos

Monetary Aggregates
M1 includes currency in circulation,
demand deposits and travellers
checks
M2 includes M1 and quasi-money
(e.g., savings deposit, small-term
time deposits)
M3 includes M2, long-term time
deposits, and repurchase
agreements.
Note! The Central Bank looks at
M3
Angelo Gabrielle F. Santos

Central Bank Balance

Sheet
Assets

Liabilities

Government Securities Currency in

circulation
Loans to Financial
Reserves of the
Institutions (Discount Banking System
loans)
International Reserves

Angelo Gabrielle F. Santos

Example: BSPs Asset side of

the Balance Sheet

Angelo Gabrielle F. Santos

Example: BSPs Liabilities side

of the Balance Sheet

Angelo Gabrielle F. Santos

Balance Sheet of the Banking

System
Assets

Liabilities

Securities

Deposits

Reserves (liability of
the BSP)
Loans to individuals,
corporations, etc

Borrowings from the

BSP and other banks

Angelo Gabrielle F. Santos

Quantitative Tools of Monetary

Policy
1. Open Market Operations (OMO)
Example: BSP buys securities worth P10M
from a bank

Assets (BSP)

Liabilities
(BSP)

For the
BSP: there is a net
increase
in
P10M
P10M
reserves
MB
securities

Assets (Bank)

Liabilities
(Bank)

P10M
securities
Angelo Gabrielle F. Santos

Quantitative Tools of Monetary

Policy
Example: BSP buys securities worth P10M
from non-bank public

Assets (BSP)
P10M
Assets (Bank)
securities
P10M Increase
Net effect:
reserves

Liabilities
(BSP)
P10M reserves

Liabilities
(Bank)

P10M deposits

Angelo Gabrielle F. Santos

Quantitative Tools of Monetary

Policy
Cont: Then, non-bank public encashes the
check and holds the currency

Assets (BSP)
P10M
securities

Assets (Bank)

Liabilities
(BSP)
P10M currency
in circulation

Liabilities
(Bank)

P10M
securities
P10M
Angelo Gabrielle F. Santos

Quantitative Tools of Monetary

Policy
2. Discount loans ()
3. Reserve Ratio Requirement
4. BSP uses the repo market

Angelo Gabrielle F. Santos

Derivation of the Money

Multiplier (mm)
(1)M DD CC
(2)MB R CC
(3)R RR ER
RR
(4.1)RR rr.DD rr
DD
ER
(4.2)ER er.DD er
DD
CC
(4.3)CC cc.DD cc
DD
Angelo Gabrielle F. Santos

Derivation of the Money

Multiplier
MB R CC

Using (2)

MB (RR ER) CC

Using (3)

MB rr.DD er.DD cc.DD Using (4)

MB (rr er cc)DD
1
(5)DD
MB
rr er cc

Angelo Gabrielle F. Santos

Derivation of the Money

Multiplier
M DD CC

Using (1)

M DD cc.DD

Using (4.3)

M (1 cc)DD

1
Using
M (1 cc)(
)MB
rr er cc
(5)
1
)
Let mm (1 cc)(
rr er cc

M mm
.MB asset side of the CBs
Where
MB=
balance sheet
Angelo Gabrielle F. Santos

Channels of Monetary
Transmission (Mishkin, 1996)
1. Interest Rate Channel

Ms ESM EDB Pbonds i I AD Y

. Inverse relationship between price of bonds and
Pbonds
the interest rate
( i
)
. Excess supply of money (ESM) => Excess demand
for bonds (EDB)
2. Exchange Rate Channel
3. Equity Price Channel (Via Tobins Q)
4. Others: see (Mishkin, 1996)
Angelo Gabrielle F. Santos

Inverse relationship between

price of bonds and interest rate
Is equal to the present value of
cash flows arising from the asset.
Present value formula:
CF1
CF2
CFn
FV
PV

...

2
n
1 i (1 i)
(1 i) (1 i)n
Where: PV= present value
CF= cash flow
FV= future value
i= interest rate
Angelo Gabrielle F. Santos

Different Types of Loans

1. Simple Loan
CFn
PV
n
(1 i)

2. Fixed Payment (FP) Loan

Price of asset= present value of cash flows

CF1 CF2 ... CFn FP

FP
FP
FP
P

...
2
n
(1 i) (1 i)
(1 i)
Angelo Gabrielle F. Santos

Different Types of Loans

3. Coupon Bond: let C= coupon
payment
CF1 CF2 ... CFn C
C
C
FV
P
...

n
1 i
(1 i) (1 i)n

4. Discount
CF1 CF2 ...Bond
CFn 0
FV
P
(1 i)n
Angelo Gabrielle F. Santos

Different Types of Loans

5. Consol or Perpetuity
. Is a coupon bond with no maturity
(FV=0).

. Coupons
are
paid
forever.
C
C
C
C
C
P

(1 i) (1 i)

...

(1 i)

n0

(1 i)

. Geometric
Series:
a1
C
C
Sn

(1 r) 1 (1 i)

i
Angelo Gabrielle F. Santos

Derivation of the Price of Consol

1
n
n1 (1 i)

Pconsol C
Pconsol

Pconsol

Pconsol
Pconsol
Pconsol

1
C
1
n
n0 (1 i)

1
C
1
1 1

1 i
1 i

C
1
1 i 1
1 i i
C

i
C

Using formula of infinite

geometric series on the
denominator

Angelo Gabrielle F. Santos

ESM and EDB

An increase in the money supply
leads to excess supply of money
(ESM). An ESM leads to an excess
demand for bonds (EDB).
Suppose there are only two assets:
money and bonds
There is asset market equilibrium
(i.e., asset supply = asset demand)
Angelo Gabrielle F. Santos

ESM and EDB

In real terms: Asset market
equilibrium
Ms
Bs Md Bd

P
P
P
P
Ms
Bs Bd
L
0
P
P
P

Where L is real money

demand

Angelo Gabrielle F. Santos

Three Cases for Asset Market

Equilibrium
1. Money market equilibrium and
bonds market equilibrium
When Ms L 0
P

Bs Bd
and

0
P
P

2. Excess supply for money and excess

demand for bonds
When Ms L 0
P

Bsand
Bd

0
P
P

3. Excess demand for money and

excess supply for bonds
WhenMs L 0
P

Bsand
Bd

0
P
P