Monetary policy in an underdeveloped country plays an important role in increasing the growth rate of the economy by influencing the cost and availability of credit, by controlling inflation and maintaining equilibrium in the balance of payments. So the principal objectives of monetary policy in such a country are to control credit for controlling inflation and to stabilize the price level, to stabilize the exchange rate, to achieve equilibrium in the balance of payments and to promote economic development.
The roles of monetary policy in a developing economy include
a. Controlling Inflationary Pressures when arising in a developed country. Here monetary policy involves application of both quantitative and qualitative methods of credit control.
b. Bank rate poilcy although a tool of monetary policy may not be so effective in developing countries
c. The use of variable reserve ratio as an instrument of monetary policy is more effective than open market operations and bank rate policy in LDCs.
d. The qualitative credit control measures are used quantitative measures in influencing the allocation of credit, and thereby the pattern of investment; and very effective than bank rate policy technique.
e. To achieve Price Stability monetary policy is an important instrument for achieving price stability. It brings a proper adjustment between the demand for and supply of money.
g. Also to bridge the balancing of payment deficit monetary policy in the form of interest rate policy plays an important role in bridging the balance of payments deficit. Under-developed countries develop serious balance of payments difficulties to fulfill the planned targets of development.
h. In developed countries, a policy high interest rate acts as an incentive to higher savings, develops banking habits and speed up the monetization of the economy which are essential for capital formation and economic growth.
i. Monetary policy in developing or underdeveloped countries also helps to Create Banking and Financial Institutions in order to encourage mobilize and channelize savings for capital formation
j. Monetary policy in underdeveloped countries also assist in Debt management
However, despite the its advantages in the underdeveloped economies, case studies from developing or underdeveloped economies has exemplified that monetary policy plays a doubting role in developing countries.
Some of the arguments in that regard are:
1. A large non-monetized populace exists in underdeveloped countries which disrupts monetary policy. Because people live in rural areas; and inimical to banking, with less baking facilities, thus, monetary policy fails to influence this large segment of the economy.
2. The money and capital markets of the LDS are not sophisticated which limit the success of monetary policy.
3. The monetary authorities are unable to control the Large Number of NBFLs non-banking financial intermediaries, hence monetary policy ineffectiveness in such countries.
4. The high Liquidity of commercial banks might render the monetary authorities credit and money control policies ineffective.
5. Foreign banks actions in underdeveloped countries, where drawing up monies and discarding foreing assets in times of Central banks policy could have an adverse effect on monetary policy. For example Bank HASBC recent withdrawal of its Nigeria operations
6. In developing countries the small bank m is less and not proportionate enough to have any meaning monetary effect. Therefore the central bank is not in a position to control credit effectively.
7. Money can be deposited in sewages, as is the example in Nigeria. The haves do not deposit money with banks and might prefer goods of ostentations which will have negative effect since they lie beyond monetary control.
Notwithstanding, Sansui in 2001 claimed that Nigeria exchange rate targeting regime during 1959-1973 was unstable when the exchange rate was regarded as the nominal anchor for monetary policy, while the period 1974-2001 was assigned to monetary targeting regime with the focus of controlling monetary aggregates so as to achieve stability of macroeconomic variables and monetary policy goals?. This observation was contrast to the CBN reports, which stated that the strategy of monetary policy in Nigeria has been targeted on money supply growth. In fact, M1 constituted the primary focus before 1986, and M2 replaced M1 since 1986.
There is an impact of monetary policy on the economy, yet the level of effect cannot be measured precisely for two reasons. First, is the transmission mechanism, i.e. how will a policy action achieve desired targets in the real economy. The second is the time lag i.e. the inevitable lagged adjustment of economic agents to changes in monetary policy. On transmission mechanism, there is the view that monetary policy affects the economy through their impact on the money supply. Another view suggests that monetary policy affect the economy through their impact on both money supply and interest rate. That is by influencing both the availability of credit and its price. When monetary policy action affects the economy through money supply it will influence the aggregate spending which in turn directly affects the production of goods and services hence the unemployment and inflation rates.
Fisher (1996) argues, ?in the imperfect world in which most Central Banks play their trade, political systems tend to behave myopically, favoring inflationary policies with short term benefits and discounting excessively their long-run costs. In assessing the effects of monetary policy in Nigeria, Ogwuma (1994), concludes that, ?the ultimate goals of macroeconomic stability and sustainable growth have so far remained elusive?. The impact on intermediate target variables also show that monetary aggregates have grown excessively and substantially above the targets set for them e.g. market rate of interest remained high, the Naira exchange rate has depreciated persistently since mid – 1980s