How do open market operations affect the U.S. money supply?

A:

Formulating a country's monetary policy is extremely important when it comes to promoting sustainable economic growth. More specifically, monetary policy focuses on how a country determines the size and rate of growth of its money supply in order to control inflation within the country.

In the United States, a committee within the Federal Reserve is responsible for implementing monetary policy. The Federal Open Market Committee (FOMC) is comprised of the Board of Governors and five reserve-bank presidents, and it meets eight times throughout the year to set key interest rates and to determine whether to increase or decrease the money supply within the economy.

The FOMC buys and sells government securities to set the money supply. The is process is called open market operations. The government securities that are used in open market operations are Treasury bills, bonds and notes. If the FOMC wants to increase the money supply in the economy it will buy securities. Conversely, if the FOMC wants to decrease the money supply, it will sell securities.

To increase the money supply in the market, the FOMC will purchase securities from banks. The funds that the banks acquire from the sale can be used as loans to individuals and businesses. The more money that is available in the market for lending, the lower the rates on these loans become, which causes more borrowers to access cheaper capital. This easier access to capital leads to greater investment and will often stimulate the overall economy.

To decrease the money supply, the FOMC will sell securities to banks, which leads to money being taken out of the banks and kept in FOMC reserves. The decrease in money available in the economy leads to a decrease in investment and spending as the availability of capital decreases and it becomes more expensive to obtain. This limiting of access to capital slows down economic growth as investment decreases.

To learn more, see Formulating Monetary Policy, The Federal Reserve and Get To Know The Major Central Banks.

RELATED FAQS

  1. What are the primary sources of market risk?

    Learn about market risk and the four primary sources of market risk including equity, interest rate, foreign exchange and ...
  2. In what types of economies are regressive taxes common?

    Understand the three main taxation systems, regressive, proportionate and progressive, and learn where regressive tax systems ...
  3. What are the advantages of using an effective interest rate figure?

    Understand what is meant by the effective interest rate, and learn why the effective rate calculation is preferred over the ...
  4. What is the Federal Reserve Board's market risk capital rule?

    Learn about the market risk capital rule enacted by the Federal Reserve, and understand how this rule reflects the Basel ...
RELATED TERMS
  1. Yield On Earning Assets

    A financial solvency ratio that compares a financial institution’s ...
  2. Bond

    A debt investment in which an investor loans money to an entity ...
  3. Sharpe Ratio

    A ratio developed by Nobel laureate William F. Sharpe to measure ...
  4. Annuity

    A financial product that pays out a fixed stream of payments ...
  5. Einhorn Effect

    The sharp drop in a publicly traded company’s share price that ...
  6. Deflationary Spiral

    A deflationary spiral is when a period of decreasing prices (deflation) ...

You May Also Like

Related Articles
  1. Economics

    Gambling on Macau: Too Risky?

  2. Mutual Funds & ETFs

    Pros & Cons Of Bond Funds Vs. Bond ETFs

  3. Bonds & Fixed Income

    African Sovereign Debt: Risks and Rewards

  4. Professionals

    Impact of SEC's New Money Market Fund ...

  5. Investing

    What Has Been Groupon’s Growth Strategy?

Trading Center