Open market operations, Managerial Economics

Open Market Operations

The Central Bank holds government securities.  It can sell some of these, or buy more, on the open market, buying or selling through a stock exchange or money market.  When the bank sells securities to be bought by members of the public, the buyers will pay by writing cheques on their accounts with commercial banks.  This means a cash drain for these banks to the central bank, represented by  a fall in the item "bankers" deposits' at the central bank, which forms part of the commercial banks' reserve assets.  Since the banks maintain a fixed liquidity (or cash) ratio, the loss of these reserves will bring about multiple contraction of bank loans and deposits.

By going into the market as a buyer of securities, the central bank can reverse the process, increasing the liquidity of commercial banks, causing them to expand bank credit, always assuming a ready supply of credit-worthy borrowers.

Conversely, if the central bank wanted to pursue an expansionary monetary policy by making more credit available to the public, it would buy bonds from the public.  It would pay sellers by cheques drawn on itself, the sellers would then deposit these with commercial banks, who would deposit them again with the central bank.  This increase in cash and reserve assets would permit them to carry out a multiple expansion of bank deposits, increasing advances and the money supply together.

Posted Date: 11/29/2012 4:49:44 AM | Location : United States

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