1.

THE
FINANCIAL AND
M O N E TA RY
REGIME
 INTRODUCTION
The financial and monetary regime is
an important element of the
economic and political environment in
which we live and work.
Understanding the basic elements of
the financial and monetary regime
will help you manage your wealth and
make you more informed about
public policy debates.
 A COUNTRY’S FINANCIAL
AN D M O N E TARY R E G I M E

Every country has a financial and monetary

regime consisting of diverse private and public
institutions and markets, and in most cases the
basic components of the financial and monetary
regime and their responsibilities are country-
invariant.

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 3 COMPONENTS OF
FINANCIAL AND
M O N E TARY R E G I M E

1. The Financial System

2. Government Financial Regulation and
Supervision
3. The Central Bank and the Central
Bank Policy

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 1. FINANCIAL SYSTEM
• The financial system consists of financial institutions
and markets (e.g., banks and insurance
companies).
• Financial markets deals in money and capital
market instruments such as commercial paper,
government bonds, corporate bonds and equities.

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FLOW OF FUNDS THROUGH THE FINANCIAL SYSTEM
INDIRECT FINANCE
FINANCIAL
INTERMEDIARIES
(e.g., Banks,
Funds, others)

LENDER-SAVERS BORROWER-
1. Households SPENDERS
FINANCIAL
2. Business firms MARKETS 1. Business firms
3. Government 2. Government
4. Foreigners 3. Households
DIRECT FINANCE 4. Foreigners
 1. FINANCIAL SYSTEM

INDIRECT FINANCE
- Funds flow from lenders to borrowers indirectly
through intermediaries like banks.
Financial intermediaries – is a financial firm
that borrows fund from savers and lends them to
borrowers.

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 1. FINANCIAL SYSTEM

DIRECT FINANCE
- Borrowers borrow funds directly from lenders in
financial markets by selling them securities
(financial instruments), which are claims on the
borrower’s future income or assets.
- Securities – are assets for the person who
buys them; but liabilities (IOUs or debts) for
individual or firm that sells (issues) them.

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 1. FINANCIAL SYSTEM
5 Basic Functions of Financial System in the Economy:
a. Institutionalize the savings-investment process
b. Provide for an efficient transfer of funds from lenders to
borrowers
c. Provide flexibility in response to the changing
requirements of different stages of economic growth
d. Provide stability in the transfer of funds from lenders to
borrowers
e. Provide a platform for the conduct of central bank policy
that ensures a wide and effective distribution of the
impact of central bank policy.

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 2 . G O V E R N M E N T R E G U L AT I O N
AND SUPERVISION
• Government regulation and supervision of the
financial system are designed to ensure the safety
and soundness of the financial system, ensure that
the financial system is transparent and ensure that
the financial system provides a wide range of
financial services to the public.
• It often adopt additional objectives to support
specific sectors of the economy or as an instrument
of social policy.

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 3. CENTRAL BANK
• The central bank is a special government institution
that conducts central bank policy designed to
influence money, credit, interest rates and the overall
level of economic activity.
• It provides a national payment systems by
establishing check-clearing facilities, wire transfer
facilities and currency.
• It can also paly a role as a financial regulatory and
supervisory authority; however, this varies from
country to country.

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THE REAL AND
FINANCIAL
SECTORS OF THE
ECONOMY Economists conceptualize the economy
as consisting of two sectors:
1. The real sector
2. The financial sector

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 The real sector focuses on the “real”
THE REAL aspects of the economic activity, which
SECTOR manifest themselves in the form of domestic
output of goods and services, foreign output
of goods and services, consumption, saving,
investment, government spending and taxes,
employment, productivity, and others.
In general, it focuses on a country’s output of
goods and services, resources that are used
to produce the goods and services, and the
prices of the goods and services in the
market.

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 The financial sector focuses on financial
THE assets and liabilities, lending and
FINANCIAL borrowing, credit, money and interest
SECTOR rates.
It focuses on the financial aspect of real
activity (e.g., instead of focusing on
spending and employment, it focus on
financial resources used to support
spending and employment, such as credit
and money).

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MEASURING
ECONOMIC
PERFORMANCE 1. Actual or real Gross Domestic
Product (GDP)
2. Potential real GDP
3. The unemployment rate
4. The natural unemployment rate
5. The price level
 ACTUAL OR REAL GDP

Real GDP is the final output of goods and services produced in

the country over a period of time, holding prices constant. It is
measured by the spending on final output measured by consumer
spending (C), investment spending (I), government spending (G)
and net foreign spending [exports of goods and services (X)
minus imports of goods and services (M).

Real GDP = C + I + G + (X-M)

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 POTENTIAL REAL GDP

The economy’s potential real GDP is the level of real output an

economy is capable of producing over a period of time utilizing its
resources with its given structure and technology.
It is simply a base to measure actual economic performance
against potential, but not optimal output.
The difference between real and potential GDP indicates whether the
economy is operating above or below its potential or natural output
path.

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A C T U A L A N D N AT U R A L E M P L O Y M E N T
R AT E
There are several measures of unemployment rate, but the most
frequently used is the civilian unemployment rate as:

UR = ((LF-E)/LF)* 100 or (NE/LF)*100

Where:
UR – Unemployment rate
LF – Labor force; which is the sum of those employed (E) and not employed
(NE)

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 A C T U A L A N D N AT U R A L E M P L O Y M E N T
R AT E
• This measure of the unemployment rate is the most frequently cited in the
news media; however, it does not accurately measure unemployment at
any point in time.
• Some individuals become discouraged and cease looking for work during periods of
labor market distress in an economic decline, and, are not included in the LF; a
reduction in the LF and NE by the same amount lowers the measured unemployment
rate and provides an inaccurate picture of the unemployment situation.
• The same phenomenon can occur in the opposite direction during the early stages of
an economic expansion, as individuals who had been on the sidelines start looking for
work, increasing the size of LF so that, at a given E, UR increases.

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 A C T U A L A N D N AT U R A L E M P L O Y M E N T
R AT E

• The natural unemployment rate is the unemployment rate in the economy

will operate when the GDP gap is zero or what amounts to the same
thing, when the economy is growing along its potential or natural growth
path.
• The more efficient the economy and the more technological progress the
lower the natural unemployment rate, and the less efficient and the
smaller the degree of technological progress the higher the natural
unemployment rate.

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 THE PRICE LEVEL
There are 4 important measures of the price level.
1. Consumer Price Index (CPI) – represents prices paid for goods and
services by the urban household.
2. Producer Price Index (PPI) – represents prices of commodities used in
the production process.
3. GDP Deflator – the price index used to convert nominal GDP to real
GDP
4. Personal Consumption Expenditure Index (PCE) – similar to CPI but
a somewhat broader measure of consumer prices.

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 THE PRICE LEVEL
• Price index is a method of measuring the average behavior of a number
of prices of items weighted by the importance of the item over time with
references to a base period; that is, the base year is set to 100 and the
index is calculated in reference to that base year.
• If the index is higher (lower) than 100, on average prices are higher
(lower) than the base year.

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THANK YOU