Federal Reserve’s monetary policy influences short term and long term flow of money and hence effecting overall spending patterns of various sectors in the economy. Open Market Operations (OMO) are one of Fed’s most frequently used tools in implementing its monetary policy. Read on to know how these operations are conducted and how they influence money flow in the economy.
Open Market Operations are:
• A means to implement monetary policy of the central bank.
• It entails buying and selling of government securities to stabilize money supply in the economy.
• Buying of securities is carried out to infuse money into the economy while securities are sold to absorb excess money.
• It is conducted through the Domestic Trading Desk at the Federal Reserve Bank of New York.
• It is a flexible and popular mechanism in influencing the availability of credit and volume of money in the economy.
• OMO are in general undertaken with short-term government securities viz., treasury bills.
When Federal Reserve intends to reduce costs of credit, interest rates, it ensures flow of money into the market. Such flow builds up reserves in the banking system and thereby reducing the rates. However, in the event of rise in inflation, Fed usually pursues a firm monetary policy intending to raise interest rates. To achieve the same, it targets to suck up the excess money in the market and limiting the availability of money with banks. Such actions result in higher interest rates.
How Fed ensures flow of money into and out of the market?
The Domestic Trading Desk at the Federal Reserve Bank of New York undertakes OMO at the directive of Federal Open Market Committee. To facilitate flow of money into the market, trading desk buys securities from a bank or securities dealer and pays money to the respective seller. Such purchase increases bank reserve to the extent of the deal and hence money is infused into the market. On similar lines, when Fed decides to shrink bank reserves, it sells securities to banks.
Federal Open Market Committee consisting of the president of Federal Reserve Bank of New York, seven members of the Board of Governors and four rotating members from the other eleven Reserve Banks is the decision making body with relation to Open Market Operations. It specifies a certain quantity of reserves to be purchased or sold and also states any change in the federal funds rate.
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