Open Market Operations Summary

Open Market Operations

How the Federal Reserve utilize the tool of open market operations (OMO) to control the supply of money in the banking systems

Analysis

The open market operation is a powerful operation tool used by the Federal Reserve that’s not as well-known as the discount rate or fed funds rate. Open market operations are when the Fed buys securities from banks when it wants the rate to fall and sells them when it wants rates to rise. The discount rate typically affects all other interest rates, including the interest rate banks charge each other for one-month, three-month, six-month, and one-year loans. It is also known as LIBOR, which affects credit card rates, adjustable-rate and mortgage rates. The rate banks charge their best customers is called the prime rate, which affects the savings account and money market interest rates. The discount rate only indirectly influences Fixed-rate mortgages and loans. They are affected mainly by the yields on longer-term Treasury notes.

The Federal reserves employ open market operations as their primary tool to influence the supply of bank reserves. The monetary tool of open market operations consists of Federal Reserve purchases and sales of financial instruments, usually securities issued by the treasury, Federal agencies and government-sponsored enterprises. When the Fed wants to increase reserves, it buys securities and pays for them by depositing to the account maintained at the Fed by the primary dealer’s bank. When the Fed wants to reduce reserves, it sells securities and collects from those accounts. Considering that the Federal Reserve control of reserves is not permanent, it usually engages in transactions reversed within several days. Moreover, the Federal Reserve controls the number of bank reserves by trading securities that affect the federal funds rate or the overnight lending rate at which banks borrow from each other.


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