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Melanie C. Yamit March 22, 2012Eco 1A 12:30-1:30 pm

Philippine Monetary SystemA Case Study

Summary

Firstly, under a centrally-managed monetary system, the supply ofmoney can be manipulated in a fast and effective manner in order toaddress emerging economic problems. This level of flexibility isn't possiblewithin a commodity-based system. The downside, of course, is that such acapability has the potential to lead to severe consequences in the form ofbubbles or hyper-inflation if mismanaged.

Secondly, most commodities, including gold, are demanded forpurposes beyond that of a medium of wealth storage and exchange. These

added sources of demand serve to increase the volatility of the relative valueof the commodity and can lead to disruptions.

Thirdly, such a system would complicate international trade, asnations with access to large reserves of the chosen commodity would be in aposition to exploit their standing. In a system of floating currencies, printingexcessive quantities of money typically results in devaluation in the foreignexchange market as well as domestic inflation.

Finally, as clarification for one of the claims you made, the economic

value assigned to fiat money does not differ, qualitatively, from the valueassigned to gold. The supply of, and demand for money determines itsrelative value.

This system, while imperfect, is preferable to a commodity-basedmonetary system for the following reasons.

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Statement of the Problem

Our modern monetary systems share in common the fact that they

consist of a nationwide, government-enforcedmonopoly of a single type ofcurrency, created by banks through loans attached to positive interest rates,and naturally or artificially kept scarce. While these particular features ofour money system have permitted the accumulation of capital that enabledrapid industrialization during the modern era, they also have a number ofhidden but far-reaching counterproductive side effects.

From Monopoly to Monetary Ecology. To be clear, the problem is

neither our national currencies nor the use of interest, but the monopolisticuse of these types of currencies which are only well-suited for certainpurposes but not for others. The fundamental problem with our currentmonetary system is that it is not sufficiently diverse, and as a result it damsand bottlenecks our creative energies, and keeps us trapped in a world ofscarcity and suffering, when we actually have the capacity to create a verydifferent reality.

Our conventional money facilitates particular types of (commercial)flows but does not adequately support other types of flows withincommunities. When a broader spectrum of currencies is in place, people cancomplete more transactions, enabling more people to meet their needs andenter into exchange relationships. Because complementary currencies donot bear interests and are issued in sufficient supply, they encouragecooperation amongst participants, and can counterbalance some of the side-effects of conventional money.

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Discussions

Medium of exchange. Money's most important function is as a

medium of exchange to facilitate transactions. Without money, all

transactions would have to be conducted by barter, which involves direct

exchange of one good or service for another. The difficulty with a barter

system is that in order to obtain a particular good or service from a supplier,

one has to possess a good or service of equal value, which the supplier also

desires. In other words, in a barter system, exchange can take place only if

there is a double coincidence of wants between two transacting parties.

The likelihood of a double coincidence of wants, however, is small

and makes the exchange of goods and services rather difficult. Money

effectively eliminates the double coincidence of wants problem by serving as

a medium of exchange that is accepted in all transactions, by all parties,

regardless of whether they desire each others' goods and services.

Store of value. In order to be a medium of exchange, money must

hold its value over time; that is, it must be a store of value. If money could

not be stored for some period of time and still remain valuable in exchange,

it would not solve the double coincidence of wants problem and therefore

would not be adopted as a medium of exchange.

As a store of value, money is not unique; many other stores of

value exist, such as land, works of art, and even baseball cards and stamps.

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.

Unit of account. 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 muchof the good to supply and how much of the good to purchase.

Conclusion

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To my conclusion, a major argument in favour of monetary policy

is that whether policy makers like it or not, governments operate in a worldof flexible exchange rates. Therefore, fiscal policy is ineffective as a tool ofdemand management, while monetary policy is effective. This paper hasshown that even in the case perfect capital flows, both conclusions are partly

wrong. With imperfect capital flows they both can be false.

This is because of the difference between the nominal and realvalues of changes in the exchange rate and money supply, aggravated bythe difference between world and domestic interest rates. Empirical evidenceon the key determining parameters suggest that under flexible exchangerates the generalization that monetary policy is more effective than fiscalpolicy requires the assumption of unrealistically high trade elasticities evenin the case of perfect capital flows. In the general case of imperfectly elastic

capital flows, the probability that monetary policy would be as effective asfiscal policy under flexible exchanges is quite low.

The impact on domestic prices exchange rate is theoreticallybeyond challenge and empirically verified. It is implied by the exchange rateitself. The necessity to incorporate the price effect of the exchange ratemeans that the logically valid formulation of the policy rule for a flexibleexchange rate regime would be, under flexible exchange rates theeffectiveness of fiscal or monetary policy depends on the import share, thetrade elasticities and the degree of capital mobility.

In other words, when formulated with theoretical consistency, theMundell-Fleming framework demonstrates there can be no specification of anopen economy model yielding the general conclusion that monetary policy iseffective.