Functioning of Open Market Operations

Functioning of Open Market Operations

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A nation's central bank can take two different open market operations related steps based on its current economic conditions:

Step 1: Purchasing Government Bonds from Banks - When a country is in a recession and has a higher unemployment rate, the central bank buys government bonds from banks. It aims to lower interest rates and increase the economy's money supply. The supply of bank reserves is increased when the central bank purchases government securities or bonds. With these new funds, banks can make more loans. Consumption and investment spending automatically rise when market interest rates fall. As a result, loans are easier to get, making it possible for more businesses to start and grow. The opportunity cost of banks lending reserves to other banks is also reduced as a result of this. In this way, the acquisition of government bonds from banks raises an economy's genuine Gross domestic product; Consequently, this strategy is also referred to as expansionary monetary policy.

Step 2: Selling Government Bonds to the Banks - The central bank sells government bonds to banks when the economy is experiencing high inflation. The market's excess money is reduced by the central bank in this manner. Subsequently, there is a reduction in the cash supply, and loan costs increment. People stop taking out expensive loans and investing in shares as a result, resulting in a significant decline in investments and consumption as a whole. The country's real GDP may also decrease as a result of a decrease in aggregate demand. This additionally diminishes the stockpile of bank holds. Contractionary open market operations are another name for this approach.

Open Market Operations Example - The RBI in India controls the flow and supply of income in the Indian economy through open market operations. In India, an example of open market operations would be in 2019, when the RBI carried out this activity for the first time in the country's history. To and from the open market, the Reserve Bank of India sells and buys government bonds from G-Secs. The primary objective is to keep the market's rupee liquidity viable. The RBI sells securities when it determines that the market has sufficient liquidity, decreasing rupee liquidity. On the other hand, the central bank purchases G-secs on the open market when it believes that liquidity is low.