Role Of Monetary Policy In A Developing Economy
The monetary policy of a developing country cannot be the same as the monetary policy of a developed country. The reason is that the economic conditions in the two types of countries are vastly different from each other. Therefore, the monetary policy of a developed country does not apply to the case of a developing country. A developed country can adopt a variety of objectives, such as full employment, price stabilisation or exchange stabilisation, according to the requirements of the economic situation. But a developing country can adopt only one objective. namely, that of economic growth for its monetary policy. The monetary policy of a developing country should serve as an effective stimulant for economic growth. In fact, for der economy, all the economic policies should be such as to serve the interests of economic growth
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The question now arises:
What should be the actual role of monetary policy in developing countries? In other words, what requirements should be fulfilled by monetary P in a developing country? In deciding its policy, the monetary authority in developing countries shall have to keep the following points in mind.
A developing economy is highly sensitive to inflationary pressures :
The reason is that in a developing economy the government incurs huge expenditures on various types of development projects. This naturally increases the effective demand in the economic output of consumer goods does not, however, increase in the same proportion in which the effective demand increases. The result is a sharp rise in the internal price level. Home monetary policy in a developing country should be able to control inflationary pressures effectively. If inflation is not checked in time, it will retard the very process o economic growth in the country concerned. To check inflationary pressures, the monetary authority should attempt as far as possible, to bring about equality between savings and investments.
As is well known, savings in a developing economy are not adequate to meet the requirements of an investment. Savings generally fall short of the requirements of investment is on this ground that the government in a developing economy tries to increase investment through credit expansion and deficit financing. If a proper check is not kept on credit expansion and deficit financing, it will surely give rise to an inflationary spiral in the economy.
It is, therefore, necessary to exercise a proper check on the volume of credit and deficit financing in the economy. The best solution would be to obviate the necessity of deficit financing by stepping up the savings of the people in the country. The monetary policy in a developing country should, thus, be conducive to the promotion of savings on the part of the public. It should be the responsibility of the monetary authority in a developing economy to extend banking facilities to those areas in the country which are either unbanked or underbanked.
The extensions of banking facilities to new areas would help in the mobilization of the idle savings of the people for investment. The monetary authority should itself set up financial institutions in the underbanked areas if that becomes necessary. It should also be the responsibility of the monetary authority to ensure that the finances flow into the priority industries as provided for in the development plan of the country. To ensure this, the monetary authority should not hesitate to utilise its regulatory powers effectively.
As is well known, the money market in a developing economy is generally divided into two sectors :
a) organised sector, and
b) unorganised sector.
The control of the Central Bank in a developing economy extends only to the organised sector. The unorganised sector lies outside the purview of the control of the Central Bank This creates several complicated: problems for the Central Bank when it attempts to control the money market of the country, What is required is that the unorganised sector should be assimilated or integrated with the banking system of the country. It should be the responsibility of the monetary authority to take steps to bring about an integration between the organised and unorganised sectors of this money market, the money market in a developing economy is also conspicuous by the absence of a well-developed bill market.
The bank deposits in such an economy form only a small and insignificant portion of the total money supply. In a developed country, on the contrary, bank deposits constitute a sizeable portion of the aggregate money supply. The monetary authority in a developing economy should try to bring about an increase in bank deposits by encouraging the development of banking habits among the people. This, in turn, will help the monetary authority itself to exercise its influence on the functioning of the economy by extending its control over the banking system of the country.
Check out these notes on Fiscal Policy.