2.5. Limitations of Monetary Policy

a) Limited Role in Controlling Prices: As per the critics, the monetary policy of Reserve bank has played only a limited role in controlling the inflationary pressure. It has not succeeded in achieving the objective of growth with stability. The role of monetary policy in combating inflation is strictly limited and monetary policy can be effective only if it is a part of an overall framework of policy, which includes not only fiscal and foreign exchange policy but also structural changes in the economy. For example, a bad monsoon in India may lead to inflation of food products. Monetary policy will not be very effective in controlling food prices in such a situation rather a mix of structural reforms (maintaining buffer stocks, reducing wastage etc) and fiscal policy (ex. Import of food grains) is desirable.

b) Existence of Black money: The existence of black money in the economy limits the working of the monetary policy. Black money is not recorded since the borrowers and lenders keep their transactions secret. Consequently, the supply and demand of money also not remains as desired by the monetary policy.

c) Large non-monetized sector: There is a large non-monetized sector which hinders the success of monetary policy in such countries. People mostly live in rural areas where barter is practiced. Consequently, monetary policy fails to influence this large segment of the economy.

d) Large number of Non- Banking Financial Intermediaries: Non-bank financial intermediaries like the indigenous bankers operate on a large scale in countries like India but they are not under the control of the monetary authority. The factor limits the effectiveness of monetary policy in such countries

e) Conflicting Objectives: An important limitation of monetary policy arises from its conflicting objectives. To achieve the objective of economic development the monetary policy is to be expansionary but contrary to it to achieve the objective of price stability a curb on inflation can be realised by contracting the money supply. The monetary policy generally fails to achieve a proper coordination between these two objectives.

f) Underdeveloped Money Market: Another limitation of monetary policy in India is underdeveloped money market. The weak money market limits the coverage, as also the efficient working of the monetary policy.

g) Influence of non-monetary factors: An important limitation of monetary policy is its ignorance of non-monetary factors. The monetary policy can never be the primary factor in controlling inflation originating in real factors, deficit financing and foreign exchange resources. The Reserve Bank has no control over deficit financing. It cannot regulate the deficit financing, which affects money supply considerably.

h) Ineffective implementation of Monetary Policy: Successful application of monetary policy is not merely a question of availability of instruments of credit control. It is also a question of judgment with regard to timing and the degree of restraint employed or relaxation allowed. However, past experience shows that Reserve Bank’s credit restrictions have always fallen short of the required extent of restraint. The Bank has adopted a hesitant attitude in the field of monetary control. In short, the monetary policy of the Reserve Bank suffers from many limitations. It requires improvements in many directions.