Open market operations refer to the selling and purchasing of the treasury bills and government securities by the central bank of any country, in order to regulate money supply in the economy.
It is one of the most important ways of monetary control that is exercised by the central banks. Under this system, the central bank sells securities in the market when it wants to reduce the money supply in the market. It is done to increase interest rates. This policy is also known as contractionary monetary policy.
Similarly, when the central bank wants to increase the money supply in the market it will purchase securities from the market, this step is taken to reduce the rate of interest and also help in the economic growth of the country. This policy is known as the expansionary monetary policy.
How do Open Market Operations take place?
Open market operations are carried out by the central bank in association with the commercial banks. For conducting such operations, there is no involvement of the public.
Government bonds are mostly bought by commercial banks, financial institutions, high net worth individuals, large business corporations. All these entities maintain accounts with the bank, and whenever these entities purchase bonds, the amount gets transferred to the central bank.
Thus, it can be said that open market operations have an impact on the deposits and reserves of the bank and also plays a role in their ability to provide credit. When a central bank wants to reduce the availability of money to the public, it will sell government bonds and securities with the help of commercial banks.
This step reduces the money supply in the economy and restricts banks to offer credit to individuals. It impacts both the supply and demand of the credit.
Similarly, at times when the liquidity conditions are tight, the central bank buys back the securities which gives the commercial banks and public easy access to the credit facilities that help in injecting liquidity into the system and stabilising the market.
This concludes the topic on open market operations which plays an important role in the monetary policy of RBI. For more such interesting concepts on Economics for Class 12, stay tuned to CoolGyan’S.
Frequently Asked Questions on Open market operations
How does open market operations work?
The open market operations work by selling and buying of the government securities by the central bank of a nation. To increase the money supply, the central bank buys back securities, while to reduce the money supply it sells securities to the commercial banks.
What is an example of open market operations?
Central banks conduct open market operations in order to regulate the money supply in the economy. For example, in India, open market operations are undertaken by the Reserve Bank of India or RBI.
Why is open market operations most used?
Open market operations are used mainly to regulate the money supply in an economy. It impacts both the supply and demand for credit.
What are the two types of open market operations?
The two types of open market operations are contractionary and expansionary. Contractionary function reduces the money supply in an economy while expansionary function eases the money supply.