Being a deliberate action by the government and that aims at controlling and influencing the cost as well as the availability of credit in order to influence the economic performance of a nation, monetary policy is conducted and controlled by the central bank. Similarly, monetary policy is one of the most used policies in macro-economics and unlike the fiscal policy, its implemented with an aim of influencing the level of aggregate economic activity. However, most of the central banks in the developing countries are faced by a number of challenges in there efforts of trying to implement monetary policy as expressed below:
i. Corruption in some of the developing countries.
If some of the developing nations experience corruption in their systems of governance and administration, it renders instruments of monetary policy such as selective credit control less effective.
ii. Knowledge deficiency regarding monetary policy instruments.
When the citizens of developing countries lack knowledge on monetary policy instruments like selective credit control and open market operation, the instruments themselves become ineffective in that the citizens will not approve them. This means that they will simply not work in the favor of these instruments.
iii. Difficulty in utilizing the traditional instruments of monetary policy in controlling money supply.
Since many citizens in developing countries do not deposit their money with commercial banks, it proves rather hard for the central banks to effectively employ their traditional tools of monetary policy to control money supply.
iv. Lack of direct linkage between lower interest rates, higher investment and expanded output.
In developing nations, investment decisions are not done using interest rate movements not forgetting that due to inflation, they experience negative real rates of interest. Instead, such decisions depend on business expectations which make it difficult for central banks to implement monetary policy.
v. The central banks lack full control over commercial banks that are branches of major foreign private banking institutions.
This is simply because such branches in developing nations are able to access liquid funds in an event of having their base squeezed by local monetary authorities like the central bank.
vi. Less sensitivity to changes in the cash bases of most of the commercial banks in developing countries.
Such a scenario appears as a result of the excess liquidity found in these commercial banks due to the rareness of credit worthy borrowers and viable projects. This makes it hard for the central banks in these nations to utilize their instruments of monetary policy effectively.
vii. Lack of developed money market and capital markets and limited quantity and range of financial assets.
With such disorganization in the money markets, the use of instruments like open market operations by the central banks in developing countries becomes extremely limited.
viii. Money supply regulation constraints caused by the openness of economies of developing countries.
Therefore, it becomes difficult for the governments of such nations to control national money supply which is done through their central banks as the accumulation of foreign currency is highly significant in availing and building their domestic financial resources.
ix. Inappropriate use of monetary policy instruments.
At times, a problem arises and the central banks of these developing countries cannot make correct decisions as to which instrument to put into use thus addressing it ineffectively. Thus, it’s vital that the central banks know when it is appropriate to use monetary or fiscal policy.
x. Volatility of the exchange rate of these developing nations’ domestic currency.
Just like Kenya, most of these developing nations work under the policies of floating exchange rate. Their economies also face increasing openness and globalization day by day thus making the exchange rate of their currencies volatile. This turns out to be a challenge to their central banks as they have to quickly come up with suitable and effective monetary measures to stabilize the exchange rates.