Limitations of Monetary Policies

Monetary policies are the tools and instruments used to influence money supply in a country in order to create the right conditions for the economy to thrive. When the economy is facing a recession, inflation, depression, or any other challenge, the government introduces monetary policies through the central bank to influence the amount of money available in the economy. For instance, when there is a high inflation, the Central Bank may raise interest rates to reduce money supply, which in turn leads to reduced demand and lower prices of goods and services. Monetary policies have significant benefits to the economy, but it also faces numerous challenges. Some of the limitations of monetary policies are listed below:

  • Commercial banks do not cooperate fully with the central bank. When a Central Bank wants to introduce a monetary policy, it uses commercial banks to do so. For example, commercial banks may be required to reduce interest rates or increase minimum deposit requirements. In some cases, commercial banks may ignore these directives, making it difficult for the Central Bank to implement its policies.
  • A government monetary system may be reduced or increased in size and controlled tightly without deleterious effects on its performance. However, monetary system contains commercial banks that are in business for profit.
  • The system may create problems for monetary authorities. This controls may weaken profit and capital positions of banking system and this may in turn make commercial banks less responsive to policies of monetary authorities.
  • Open Market Operations (OMOs) are not quite virtually effective in controlling money supply due to less developed money and capital markets and limited range of financial assets (securities).
  • On reserve requirement, some commercial banks have access to external lines of credit from partners/their parent companies.
  • Funding-may be effective in controlling liquidity. However since the rate of interest on long term debt is usually much-higher than on short-term loans.

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