i)It is the purchase and sale of government securities by Central Bank of a country.
The sales of securities leads to a contraction of credit and purchases lead to expansion of credit thereof.
OMO is sometimes adopted to make the bank rate policy effective, if the member’s banks do not raise the lending rate following the rise of bank rate due to surplus funds available
The Central bank can withdraw such surplus by sale of securities and thus compel member banks to raise the rates.
ii)OMO may not be effective because the sale securities may offset by return from circulation of cash on hoards.
The purchase of securities on the other hand may be accompanied by a withdrawal notes from currency required for holding in cases the cash reserves remain unaffected
Even if the reserve of member’s banks is increased the bank may not expand credit. The percentage of cash credit is rigidly fixed and cash vary within wide limits
The banks will contract and expand credit owing to the prevailing economic and political circumstances
Owing to political and economic uncertainty money may not attract borrowers and thus when trade is good and prospects of profit is high entrepreneurs borrow even at high rates.
The circulation of bank money should have a constant velocity but the velocity of bank deposits is never constant. It increases in times of high production decrease times of depression. Thus policy of contracting credit is neutralized by increased velocity of circulation.
Kavungya answered the question on March 26, 2019 at 05:55