After a banking crisis, when the Federal Reserve buys government securities to increase the money supply and decrease interest rates:
A)consumers and businesses may not respond by increasing their spending because of debt overhang.
B)consumers and businesses usually borrow too much and spend too much, causing inflation.
C)banks may fear runs, so they hold on to excess reserves rather than lending them to consumers and businesses.
D)consumers and businesses may not respond because the recession has increased the value of their assets so much that they don't need to borrow money to buy more.

Question

Quizplus · Accepted Answer

Even if the Fed increases the money supply and decreases interest rates, consumers and businesses may not be willing to increase their spending due to debt overhang. Debt overhang refers to the situation where consumers and businesses already have a lot of debt, and hence, they are not willing to take on more debt even if the interest rate is low. This can limit the effectiveness of the Fed's actions in stimulating the economy.

After a Banking Crisis, When the Federal Reserve Buys Government