11) During the 1920s the Fed used its Open Market Operations to expand credit an
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Question
11) During the 1920s the Fed used its Open Market Operations to expand credit and increase liquidity in financial markets. They did so with the intention of reducing the cost of capital and facilitating funds flow to businesses, believing that this operation would increase business investment and expand the economy.Some economists warned of the dangers of this policy, and later identified it as a significant cause of the Great Depression.What are the primary dangers of an "easy money" Fed policy? (Be sure to consider the potential effects on capital investment and capital markets)Explanation / Answer
Open market operations refers to the buying and selling of government securities in the open market in order to expand the money supply in the market.
Limitations of open market operations are:
1) Lack of well-developed securities market: There must be strong and active securities market for successful of open market operations.Due to lack of such a market open market policy ineffective.
2) Contradictions between bank rate and open market operation: The sale of securities by the central bank may ineffective keepin check the loanable resources of the banks and failed to restore the reserves.
3) Difficulties in executionof open market operations: To execute a policy by the central bank is not as difficult as compared to the sale of securities in open market operations. Similarly, for commercial banks, a policy of credit contraction is easier to implement than a policy of expansion. Therefore, the operation of money factors alone open market operations can stop booms but cannot prevent slumps.
4)Despite expansionary monetary policy, there is still no guaranteed economy recovery: Some economists criticize the Federal Reserve on the policy say that in times of recession, not all consumers will have confidence to spend and take advantage of low interest rates.
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