Open Market Operations

Published Jan 8, 2023

Definition of Open Market Operations

Open market operations (OMO) are a type of monetary policy used by central banks to influence the money supply in an economy. That means they are used to buy and sell securities (e.g., U.S. Treasury securities) in the open market in order to increase or decrease the money supply and interest rates.

Two types of OMOs can be distinguished: permanent and temporary open market operations. The former refer to actual purchases or sales of securities in the open market, while the latter describe temporary transactions that revolve around securities (e.g., repurchase agreements, reverse repurchase agreements).

Example

Let’s look at an example to illustrate how OMOs work. Assume the Federal Reserve (FED) (i.e., the central bank of the U.S.) wants to increase the money supply in the U.S. economy. To do this, it buys government securities from commercial banks in the open market. This increases the money supply in the economy because the FED pays for those securities with newly minted USD or money it had in its vault (note: money that is stored in the FED’s vault is not considered part of the money supply). As a result, commercial banks now have more money to lend out, which stimulates economic activity.

Why Open Market Operations Matters

Open market operations are an important tool for central banks to influence the money supply in an economy, along with reserve requirements and discount rates. These tools help them to meet their monetary policy goals.

In addition to that, OMOs can also affect the federal funds rate and other interest rates in the economy. This, in turn, helps to stimulate economic growth or slow down the economy if needed.

Therefore, OMOs are a critical component of monetary policy to manage the money supply and interest rates in an economy and to achieve macroeconomic goals.