Loading the player...

What are 'Open Market Operations - OMO'

Open market operations (OMO) refers to the buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system, facilitated by the Federal Reserve (Fed). Purchases inject money into the banking system and stimulate growth, while sales of securities do the opposite and contract the economy. The Fed's goal in using this technique is to adjust and manipulate the federal funds rate, which is the rate at which banks borrow reserves from one another.

BREAKING DOWN 'Open Market Operations - OMO'

OMO is the most flexible and most common tool that the Fed uses to implement and control monetary policy in the United States. However, the discount rate and reserve requirements are also used.

The Fed can use various forms of OMO, but the most common OMO is the purchase and sale of government securities. Buying and selling government bonds allows the Fed to control the supply of reserve balances held by banks, which helps the Fed increase or decrease short-term interest rates as needed.

Federal Open Market Committee

The Federal Open Market Committee (FOMC) is the Fed's committee that decides on monetary policy. The FOMC enacts its monetary policy by setting a target federal funds interest rate and then implementing OMO, discount rate or reserve requirement strategies to move the current federal funds rate to target levels. The federal funds rate is extremely important to control because it affects most other interest rates in the United States, including the prime rate, home loan rates and car loan rates.

The FOMC normally uses OMO first when trying to hit a target federal funds rate. It does this by enacting either an expansionary monetary policy or a contractionary monetary policy.

Expansionary Monetary Policy

The Fed enacts an expansionary monetary policy when the FOMC aims to decrease the federal funds rate. The Fed purchases government securities through private bond dealers and deposits payment into the bank accounts of the individuals or organizations that sold the bonds. The deposits become part of the cash that commercial banks hold at the Fed, and therefore increase the amount of money that commercial banks have available to lend. Commercial banks actively want to loan cash reserves and try to attract borrowers by lowering interest rates, which includes the federal funds rate.

Contractionary Monetary Policy

The Fed enacts a contractionary monetary policy when the FOMC looks to increase the federal funds rate and slow the economy. The Fed sells government securities to individuals and institutions, which decreases the amount of money left for commercial banks to lend. This increases the cost of borrowing and increases interest rates, including the federal funds rate.

RELATED TERMS
  1. Monetary Policy

    Monetary policy is the actions of a central bank, currency board ...
  2. Federal Discount Rate

    The interest rate set by the Federal Reserve that is offered ...
  3. Key Rate

    The specific interest rate that determines bank lending rates ...
  4. Federal Funds

    Excess reserves that commercial banks deposit at regional Federal ...
  5. Federal Open Market Committee - ...

    The branch of the Federal Reserve Board that determines the direction ...
  6. Federal Reserve System - FRS

    The central bank of the United States. The Fed, as it is commonly ...
Related Articles
  1. Insights

    Open Market Operations vs. Quantitative Easing

    How does the Fed's implementation of Quantitative Easing differ from its more conventional open market operations?
  2. Personal Finance

    How the Federal Reserve Affects Your Mortgage

    The Federal Reserve can impact the cost of funds for banks and consequently for mortgage borrowers when maintaining economic stability.
  3. Trading

    How Do Central Banks Inject Money Into The Economy?

    Central banks inject money into the banking system, and remove money from it, through monetary policy actions.
  4. Insights

    How Much Influence Does The Fed Have?

    Find out how current financial policies may affect your portfolio's future returns.
  5. Investing

    How The U.S. Government Formulates Monetary Policy

    Learn about the tools the Fed uses to influence interest rates and general economic conditions.
  6. Personal Finance

    What's the Federal Funds Rate?

    The federal funds rate is the interest rate banks charge each other for overnight loans to meet their reserve requirements.
  7. Insights

    How The Federal Reserve Manages Money Supply

    Find out how the Fed manages bank reserves and this contributes to a stable economy.
  8. Insights

    Not Crazy: Unconventional Monetary Policy

    Unconventional monetary policy, such as quantitative easing, can be used to jump-start economic growth and spur demand.
RELATED FAQS
  1. How are interest rates related to open market operations?

    Learn about open market operations and how this monetary policy tool impacts interest rates. Find out how the Fed combats ... Read Answer >>
  2. How does monetary policy impact the cost of debt?

    Learn how monetary policy impacts the cost of debt. This economics lesson explains how the Federal Reserve influences interest ... Read Answer >>
  3. How do central banks inject money into the economy?

    Central banks use several different methods to increase (or decrease) the amount of money in the banking system. These actions ... Read Answer >>
  4. How do open market operations affect the money supply of an economy?

    Understand how open market operation affect the supply of money in the economy and learn the specific ways the Federal Reserve ... Read Answer >>
  5. When was the last time the Federal Reserve hiked interest rates?

    Learn about when the U.S. Federal Reserve last increased the federal funds target rate, which was in June 2006 after the ... Read Answer >>
  6. What precise measures are implemented in most monetary policies?

    Read about some of the precise measures implemented in most monetary policies, and learn why monetary policy is considered ... Read Answer >>
Hot Definitions
  1. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  2. Down Round

    A round of financing where investors purchase stock from a company at a lower valuation than the valuation placed upon the ...
  3. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  4. Portfolio Investment

    A holding of an asset in a portfolio. A portfolio investment is made with the expectation of earning a return on it. This ...
  5. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  6. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
Trading Center