7 Functions of Monetary Policy– Discussed!

Read this article to learn about the seven functions performed by monetary policy in developing economy.

(i) Monetary policy should try to maintain in the economy a most suitable interest rate structure.

At present the interest structure is amendable only in the upward direction and very little in the downward direction, but with the help of monetary policy the structure becomes somewhat manageable in the downward direction also.

For a large public debt that has to be raised in poor economies, rates of interest must be kept low.

(ii) Monetary policy can be of great use in these economies for effecting necessary adjustment between the demand for and supply of money. The demand for money is likely to go up on account of increased transactions and gradual disappearance of non-monetized sector combined with increased demand for money on account of precautionary and speculative motives. The use of money and credit for speculative purposes has to be controlled by the monetary authorities through suitable monetary policy and by the government through direct physical controls, failing which, inflation is likely to appear, which may stifle growth instead of helping it.

(iii) Monetary policy can, perhaps, be more useful in influencing the pattern of investment and production by controlling the provision of credit by banks. It can induce the banks to advance medium-term and long-term loans of productive nature at the same time prohibiting them to advance loans of unproductive and speculative nature.

(iv) Monetary policy can help in the expansion of financial institutions by granting subsidies and special facilities to new institutions and provision of training facilities for their staff. In most of the underdeveloped countries the credit system is restricted to providing credit for large estates, plantations and to foreign traders, and are not available to farmers, small traders and industries.

In such a situation an extension of commercial bank, co-operative bank and savings bank facilities can encourage development and mobilize savings for productive purposes. Therefore, it is said that the creation and mobilization of real savings—the most important condition for growth—is helped or hindered by monetary policy and by the development of financial institutions.

(v) Monetary policy can prove more effective through selective credit control. Poor economies are extremely inflation-sensitive on account of speculation in commodities that are in short supply, like wheat and rice. This speculation is done mostly by borrowed funds got from the banks. Monetary policy can be made use of to stop borrowing for speculative purposes and to divert them for productive purposes.

(vi) Monetary policy can also help growth. The sectoral impacts of such policy in a developing economy are worth noting. Monetary expansion can be used, at least in theory, to change the terms of trade against the agricultural sector, which tends to benefit from increased production in the secondary or tertiary sectors. If the prices of industrial goods can be raised through inflation without affecting the prices of food-stuffs and raw materials, it may prove useful for growth but in actual practice it may be difficult to follow.

(vii) Monetary policy in a developing economy should also be concerned with the balance of payments problem. When a country starts developing, its balance of payments may become adverse on account of various reasons. Under such circumstances, besides, exercising direct controls on foreign exchange, the monetary authority can help in turning the balance of payments favourable by using the traditional methods of control, like raising the bank rate, etc.