A:

The open market operations conducted by the Federal Reserve affect the money supply of an economy through the buying and selling of government securities.

When the Federal Reserve purchases government securities on the open market, it increases the reserves of commercial banks and allows them to increase their loans and investments; increases the price of government securities and effectively reduces their interest rates; and decreases overall interest rates, promoting business investments.

If the Federal Reserve were to sell government securities on the open market, the opposite would be true. It would decrease the reserves of commercial banks and reduce their loans and investments, decreasing the price of government securities and increasing their interest rates, and increasing overall interest rates, reducing business investments.

The Federal Open Market Committee (FOMC) specifies and decides on short-term objectives for open market operations. The FOMC sets a target federal funds rate and uses open market operations to adjust the supply of reserve balances to achieve that target.

(For related reading, see: How Central Banks Control the Supply of Money.)

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