What is an Open Mouth Operations
Open mouth operations are speculative statements made by the Federal Reserve System (FRS) to influence interest rates and inflation. Open mouth operations are the announcements by the Fed, also known as the central bank when it informs exchanges where the preferred interest rates should be, and not the action of the sale or purchase of U.S. Treasury securities.
The potential use of open market operations by the central bank is to reach target interest rates. Their announcement typically causes the market to react. Marketplace reactions tend to adjust interest rates without the need of the central bank taking action.
BREAKING DOWN Open Mouth Operations
Open mouth operations broadcast where the Fed, or central bank, believes interest, rates and inflation should be. When an action is taken on a Fed statement, it is known as open market operations (OMO). Open market operations (OMO) refer 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.
Open Market Operations as a Result of Open Mouth Operations
There are several forms of open market operations (OMO), the most common of which is the sale of government or Treasury department securities. If marketplace response does not move interest rates and inflation as intended by the Fed, they may take steps themselves to enact the changes.
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. Purchases of Treasury securities inject money into the economy and stimulate growth while selling those same securities can cause the economy to contract.
Regarded as a flexible tool, the Federal Reserve controls monetary policy in the U.S. as it facilitates the OMO process to adjust and manipulate the federal funds rate. The federal funds rate is the standard paid when banks borrow funds from one another. Fed funds rate is one of the most important interest rates in the U.S. economy. It affects monetary and financial conditions, critical aspects of the broad economy including employment, and short-term interest rates for everything from homes to credit cards.
Structure of the Federal Reserve System
The Federal Reserve System, or the central bank of the United States, regulates U.S. monetary and financial policy. It is composed of a central governmental agency in Washington, D.C., the Board of Governors and 12 regional Federal Reserve Banks. Reserve Banks are located in major cities throughout the United States.
The Federal Reserve's monetary policy regulates banking institutions, monitors and protects the credit rights of consumers, maintains the stability of the financial system, and provides financial services to the U.S. government.
Monetary policy decisions fall to the Federal Open Market Committee (FOMC).
The FOMC enacts its policy by setting the target federal funds rate. Communication of this rate is through open mouth operations. If necessary, the FOMC will then implement open market operations, discount rate, or reserve requirement strategies to move the current federal funds rate to target levels. The federal funds rate affects most other interest rates in the United States, including the prime, home loan, and car loan rates.