(b) Outside Lag: The outside lag is the time taken by the households an:i the firms to react in response to the policy action taken by monetary authorities. If operational lags a:e long in the nature and magnitude of the problem they may change rendering the policy ineffective.
The time lag of monetary policy particularly the response lag is found to b ruch longer than the time lag of fiscal policy. According to Friedman and Schwartz, an average tire lag is of 18 months between peaks ftroughs) of money supply and peaks (troughs) of business cycle.
2. Problem in Forecasting: To formulate an appropriate monetary policy, magnitude of the problem must be assessed. More important is to forecast the effects of monetary action, prediction of the outcome of a policy action and hence formulation of an appropriate monetary policy is a very difficult task. An appropriate policy based on guess work is bound to be unsatisfactory.
3. Non-Banking Finandal Intermediaries: The structural change in the financial market has reduced the scope of effectiveness of monetary policy. The proliferation of non-banking financial intermediaries including industrial finance corporations, industrial development banks, mutual saving funds, etc. has reduced the share of the commercial banks, in the total credit.
4. Under Development of Money and Capital Market: In underdeveloped countries the character of their money and capital markets is also underdeveloped. Their money and capital markets are fragmented while effective working of monetary policy required that money market and the sub-market of the capital market work independently. So the effects of change in money supply and in the interest rates remained confined to banking sector only.
Instruments of Monetary Policy•
Instruments of monetary policy refer to the economic variables that the Central Bank can change with a view to control and regulate the money supply and the availability of credits. These instruments of monetary policy are also known as weapons of monetary control.
The measures of monetary policy are generally clarified under two categories:
(i) Quantitative measures.
(ii) Qualitative or selective credit controls.
Traditional measures of monetary control are as follows:
(A) Open market operations.
(B) Bank rate policy.
(C) Cash Reserve Ratio (CRR).
[A] Open Market Operations
Sale and purchase of government securities and treasury bills by the Central Bank of the country makes an open market operation. To increase the supply of money to the public, Central Bank purchases government securities, i.e, bills and bonds. Similarly when it decides to reduce money it sells the government bonds and securities. The open market operation has not proved a powerful tool in the hands of RB!
Effectiveness of Open Market Operations
(i) When commercial banks possess excess liquidity, the OMO does not work effectively.
(ii) ma very buoyant market situation, the effective control of demand for credit through open market operation is doubtful. During the depression period, open market operations are not effective for’lack of demand for credit.