Page 247 - DECO402_Macro Economics

Macroeconomic Theory

Notes institutions like NBFIs. This happens because different from commercial banks, they are not
in a conditions to keep themselves balanced in fast increasing interest rates.
5. Changes of Expectations of Borrowers and Lenders: A very expensive monetary policy
may change the expectations of borrowers and lenders. That is why they bring unchangeable
changes in credit market situations. Sharp increase in interest rates changes the expectations
so much that when this policy is given up and an expansionary monetary policy is started,
even then lender are unwilling to give long term loans with an anticipation of further increase
in interest rates. At the other side, borrowers, with an anticipation of increase in interest rates
in future, may take long term loans though they do not need it.
6. Time Lags: One more limitation on effectiveness of expensive monetary policy is that there
are time lags in need for action and identification, decision and popularization of action.
Since due to these time lags monetary officers are not able to follow measures of restrictive
monetary policy on time that is why monetary policy works very slowly. Hence it is not
very effective in controlling inflation.

Self Assessment

State whether the following statements are true or false:
7. Monetarists have the opinion that central bank may increase the reserves of commercial
banks during depression, through cheap monetary policy.
8. Full employment is not kept under the main objectives of monetary policy.
9. There is an important limit of effectiveness of monetary policy in stopping inflation—increase
in velocity of money kept with the public.
10. When banks sell governments securities to central banks, their price in the market rise up.

27.6 Role of Monetary Policy in a Developing Economy

In a developing economy, monetary policy does an important job in increasing economic growth by
influencing cost and sufficiency of credit, by controlling the inflation and maintaining the equilibrium
of balance of payment. Hence in such countries main objectives of monetary policy is to control credit,
stabilise exchange rate for controlling inflation and for stabilising prices, attain equilibrium in balance
of Payment and increase economic growth.
1. To Control Inflationary Pressures: For attaining control on inflationary pressures created
during the process of development, both quantitative and qualitative measure credit control
of monetary policy are required. In tools of monetary policy, open market operations are
not successful in controlling credit in undeveloped countries because bill market is small
and undeveloped. Commercial banks keep flexible cash deposit ratio because they are not
completely controlled by the central bank. Because of relatively low interest rate from them,
they are unwilling to invest in government securities. Apart from this instead of investing
in government securities they like to keep their reserves in liquid form like gold, foreign
exchange and cash. Commercial banks also to not want to take loans or do re-discounting
from central bank.
Bank rate policy is also not that effective in such countries because of the following reasons:
- (i) shortage of discount bills; (ii) contracted shape of bill market; (iii) huge non-monetised
field where goods exchange happens (iv) existence of local banks which do not do discounting
of bills with central bank; (v) tendency of commercial banks of keeping large cash reserve;
and (vi) being of large unorganised money market.

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