Monetary policy in a developing country is an important instrument in the hands of the central bank which may be used to ensure economic growth. However, the success of monetary policy is subject to some crucial limiting factors.
The Limitations of Monetary Policy in Developing Economy is discussed below:
Limitations of Monetary Policy in Developing Economy
(i) Underdeveloped Money and Capital Market. The central bank cannot effectively implement the various credit control measures in the absence of well-organized money and capital markets. Underdeveloped countries do not have well developed and fully organized money and capital market.
(ii) No Integrated Rate of Interest Structure. The banking sector in underdeveloped countries is unorganized from where a sizeable financial resources come. There is therefore, no integrated rate of interest and therefore the central bank fails to influence the market rate of interest by changing the bank rate. In fact, the change in bank rate must be reflected in the form of increased or decreased market rate of interest.
(iii) Lack of Cooperation among Commercial Banks. The monetary policy cannot be effectively implemented in the absence of cooperation between the commercial banks and the central bank because the central bank can implement its monetary policy through commercial banks in developing countries there is no such cooperation of commercial banking institutions with the central bank and in some case the banks flout the central bank directives. Without proper coordination and cooperation between the two institutions, monetary policy cannot succeed.
(iv) Banking Habits of the People. In developing countries, people are not habitual to bank their savings due to low level of Income and savings and lack of banking facilities. Consequently, most of the transactions are entered into cash and not through credit instruments. It is for this reason that the credit control measures of the central bank do not have desired effect on the business activities.
(v) Illiteracy and Social Obstacles. Most of the developing countries suffer from mass illiteracy, superstition, dogmatism and many other social evils. People do not understand the significance of banking institutions hence they do not deposit their money into or take loans from the banks. The success of monetary policy depends upon the widespread banking institutions, banking habits of the people adequate development of credit facilities entrepreneurial ability etc.
To sum up, there are number of Limitations of Monetary Policy in Developing Economy. The monetary authority in such a country should create necessary conditions whereby the banking and financial institutions may flourish and people may be educated to bring their savings to these institutions. The authority should manipulate the monetary policy in such a manner as to step up saving and investment activities for accelerating the rate of economic growth.