Page 249 - DECO402_Macro Economics

Macroeconomic Theory

Notes because high interest rates are hurdle in development but experienced results tell this that
in developing countries investment in trade and industry is interest-inflexible but in net cost
of investment, interest has a very little ratio. Despite of these opposing opinions, it is correct
for the monetary officer to follow discriminatory interest rate policy. According to this policy
for high interest rates should be there for unnecessary and unproductive experiments and
for productive experiments low interest rates should be there.
5. To Create Banking and Financial Institutions: In LDCs, one objective of monetary policy
is to establish and develop banking and financial institutions for collecting, floating and
inducing savings. Monetary officer should encourage establishment of branch banking in
rural and urban areas. Such policy will be helpful in monetization of non-monetized area
and will induce saving and investment for capital building. It will also organise and develop
money and capital market. It is necessary of developmental monetary policy, in which debt
management is also included.
Debt Management: In a developing country, managing public debt is one of the important tasks
of monetary policy. Its objective is to issue government bonds on appropriate time, stabilising their
prices and minimising the service costs of public debt. Main objective of debt management is to create
such situations in which public debts keep increasing year on year. In such countries public debts
are necessary for controlling money supply and providing finance to development programmes. But
public debt should necessarily be at cheap rates. Low interest rates increase the price of government
bonds and make them more attractive for the people. They also feel the weight of debt to be less.
Conclusion: In this way entire monetary policy, as has been told above, is helpful in controlling
inflation, reducing the Balance of Payment gap, inducing capital building and in increasing the
economic development.

Limitations of Monetary Policy in LDCs

Experience of developing countries tells that monetary policy has a limited role in such countries.
Below mentioned are its reasons:
1. Large Non-Monetized Sector: In such countries there is large non monetized area which is
a hurdle in success of monetary policy. Most of the people live in rural areas where there
is a trend of goods exchange method. Consequently, monetary policy is unsuccessful in
influencing a wide part of the economy.
2. Undeveloped Money and Capital Market: Money and capital markets are undeveloped.
There is a lack of bills, stocks and shares which limit the success of monetary policy.
3. Large number of NBFIs: In such countries local bankers such as Non Banking Financial
Intermediaries work on a large scale, but they do not come under the control of monetary
officer. Because of this reason also effectiveness of monetary policy is limited in such
countries.
4. High Liquidity: High liquidity is found with the commercial banks because of which they
are in affected by the credit policy of the central bank. It also makes the monetary policy
less effective.
5. Foreign Bank: Almost in all developing countries foreign commercial banks are there. They
also by selling the foreign assets and by taking out money from their main office, make the
monetary policy less effective, while central bank may be following expensive monetary
policy.

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