Open Market Operations

Even though open market operation are considered to be the principal tools of a monetary policy, not many people will claim about knowing what it actually means. The common man seems to be more comfortable staying ignorant about the economic policies, than trying to figure out what they mean and how they affect him. In the United States, the concept also includes buying and selling of previously issued U.S. government securities by the Federal Reserve System (also known as Fed). Even though the concept is more or less same in all the economies of the world, you may observe some difference in the methods by which it is carried out. Similarly, the objectives of open market transactions may differ from one economy to another.

Open Market Operations Explained

It is the process of implementing a monetary policy by which the central bank controls the total money supply by controlling the term interest rate and the supply of base money within the economy. When it comes to the U.S. economy, this definition can be put as trading of government securities in the open market. While purchasing of these securities can facilitate growth in the economy, their sale does the exact opposite. This buying and selling of securities helps in stabilizing the economy. During an inflation, when too much of money in the market affects the value of a dollar, sale of securities helps in taking out the money from the economy and stabilizing it. The targets used in implementation of open market operations include inflation, interest rates, exchange rates, etc. The targets of these operations differ from one section to another. Its most important goals include attaining a specific short term interest rate in the debt markets, growth of the money supply, achieving and maintaining a fixed exchange rate etc.

Examples

The United States of America and the European Union are two bigwigs of the world economy. In the U.S. economy, the Federal Reserve System - the central bank of the US, is responsible for the formulation and implementation of monetary policies. Within the Federal Reserve System, there is the Federal Open Market Committee (FOMC) which is supposed to monitor the policy making process of the open market operations. When the Federal Reserve buys securities from a particular dealer, the payment is done by crediting the reserve account of the dealer's bank at a Federal Reserve Bank. When Federal reserve sells securities to a particular dealer the payment by the dealer helps in reducing reserves of the dealer's bank as well as the monetary system. In Eurozone, the European Central Bank resorts to this concept to stabilize the interest rates and manage liquidity in the market. In Europe, though, it is a four-tier system which has certain steps which are executed at specified intervals.

In the United States, the most important duty of the Fed is to stabilize the economy by managing the money supply of the nation. In order to do this, the Fed uses three tools of monetary policy. Open markets operation is one of the three, while the other two are discount window borrowing and reserve requirements. In order to maintain stability in the economy, the monetary policy has to be very elastic, and these three tools of the policy ensure that it stays elastic.