Open Market Operations

What is Open Market Operations?

In simple language, we can understand open market operations (OMOs) as the process of selling and purchasing treasury bills and government securities by the central banking institution of any country. The primary purpose of OMOs is to regulate the supply of flow of money in the economy. Another motivation of open market operations can be to control the short-term interest rates of the banks in the country. Now that we have elucidated the basics of OMOs, let us try to answer the question – what is open market operations – in greater detail.

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Features of Open Market Operations

Open market operations or OMOs are the fundamental and the most doable monetary control exercised by central banks of diverse countries. In simple vocabulary, what happens in OMOs is that the central bank sells securities in the open market to cinch the money supply in the market. As such, the interest rates increase. OMOs are also termed the Contractionary Monetary Policy. Likewise, when the apex bank desires to elevate the money supply in the market, it purchases securities from the money. The step is undertaken to reduce or alleviate the interest rate and enhance the country's economic development. The process of buying securities from the open market is alternately deemed as the Expansionary Monetary Policy. 

  • Open Market Operations RBI is the process wherein the apex bank purchases or sells treasuries and other securities from the open market to regulate money flow.

  • In the USA, open market operations are controlled by the Federal Bank. It utilizes open market operations to manipulate the interest rates, particularly the federal units rate used in interbank loans.

  • In India, open market operations RBI are controlled by the Reserve Bank of India. It buys securities to increase the money flow in the economy, makes obtaining loans more accessible, and reduces the interest rates on loans. On the contrary, the RBI sells securities or treasuries to deflate the money supply in the economy, make obtaining loans a more difficult task, and increase the rate of interest on loans.

Now that we have highlighted the features of the open market operations RBI let us gauge its various other nitty-gritty.

Outright Open Market Operations – Federal Bank Example

To understand open market operations in India, it is vital to grasp how the USA's Federal Reserve dictates the nation's monetary policy. The USA provides the best open market operations example for us to understand its many nuances. To maintain the stability of the US economy and stall the demerits of inflation or deflation, the Board of Federal Reserve sets a target known as the federal funds rate. We can understand the federal fund rates as the interest percentage banks charge each other for overnight loans. This regular flow of massive sums of money allows banks to ensure that their cash reserves are high enough to meet the customers' demands. The federal funds also embody a benchmark for other interest rates, thereby influencing the direction of everything ranging from savings deposit rates to home mortgage rates and credit card interest.

In other words, open market operations act as an instrument that the Federal Bank utilizes time and gain to increase the money supply and lower the market interest rate by using newly created money. Likewise, the Federal Bank also exerts positive pressure on banks.

Open Market Operations in India

In 2019, the Reserve Bank of India conducted its version of the open market operations for the first time in history. In India, OMOs are regulated by the RBI by selling and purchasing government securities of G-Secs to and from the market. The primordial goal is to adjust the rupee liquidity conditions within the market on a viable basis. When the RBI feels that there is more than enough liquidity in the market, it sells securities and reduces the rupee liquidity. On the contrary, when the Reserve Bank of India feels that the liquidity scenario is tight, it resorts to purchasing G-secs from the open market.

In conclusion, we can assert that open market operations are vital aspects of an economy. They are integral to ensuring a steady and regulated supply of money within the market.

FAQs on Open Market Operations

1. What are the types of open market operations?

There are two types of open market operations – permanent open market operations and temporary open market operations.

  • Permanent Open Market Operations (POMO) – It entails the apex bank of any country consistently using the open market to sell and purchase securities or treasuries to adjust the money supply. It is used as a tool to influence the economy.

  • Temporary Open Market Operations – They are used to add or drain reserves to or from the banking system on a short-term basis. Temporary open market operations are transitory in nature, and they are operated through repurchase agreements or Repos or reverse repurchase agreements or RRPs.

2. Can you highlight the various advantages of open market operations?

There are various advantages of open market operations or OMOs. Firstly, OMOs are flexible in terms of the amounts bought and sold. They are easily reversible, and their impact on the bank reserves is also trickling and slow. Another considerable merit of open market operations is that they are entirely controlled by one banking institution – the apex bank.

3.  What are the limitations of open market operations?

Despite many advantages, we can't ignore the limitations of open market operations. The first disadvantage of OMOs is that their process mandates the existence of a well-developed securities market. Secondly, there may be contradictions between the bank rate and open market operations. Thirdly, the preparedness of the apex or central bank is paramount in determining the success of open market operations. Furthermore, their execution is complex in real life. It is noteworthy that OMOs are highly successful in preventing booms but not so much in preventing slumps in the economy.