Loading the player...

What are '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. Securities' purchases inject money into the banking system and stimulate growth, while sales of securities do the opposite and contract the economy.

The Federal Reserve (Fed) facilitates this process and uses this technique 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'

Open market operations (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 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 Open Market Operations 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.

When the amounts of funds available to loan increases, interest rates go down. A decrease in the cost of borrowing means that more people and businesses have access to funds at a cheaper rate. This leads to less savings and more spending. An increased spending fuels the economy, leading to lower unemployment.

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.

When the cost of debt increases, individuals and businesses are discouraged from borrowing, and will opt to save their money. The higher interest rate means that the interest in savings accounts and certificates of deposit (CDs) will also be higher. To take advantage of the savings rates, entities will spend less in the economy and invest less in the capital markets, thereby, slowing inflation and economic growth.

RELATED TERMS
  1. Federal Funds Rate

    The federal funds rate is the interest rate at which a depository ...
  2. Key Rate

    The specific interest rate that determines bank lending rates ...
  3. Target Rate

    The interest rate charged by one depository institution on an ...
  4. Tight Monetary Policy

    A course of action undertaken by the Federal Reserve to constrict ...
  5. Expansionary Policy

    A macroeconomic policy that seeks to expand the money supply ...
  6. Easy Money

    In the most literal sense, money that is easily acquired. Academically ...
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. Investing

    The Fed's Tools for Influencing the Economy

    The economy can be volatile when left to its own devices. Find out how the Fed smoothes things out.
  3. 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.
  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. Insights

    What Does the Federal Reserve Do?

    What is the Federal Reserve System and how does it affect interest rates, inflation and the market?
  7. Investing

    How Do Interest Rates Affect the Stock Market?

    Interest rates can have a complicated ripple effect through financial markets. Here's what you need to know.
RELATED FAQS
  1. How do open market operations (OMOs) affect bond prices?

    Find out why OMOs affect bond prices. Learn how the Fed influences money supply and the relationship between interest rates ... Read Answer >>
  2. What are the implications of a low Federal Funds Rate?

    Find out what a low federal funds rate means for the economy. Discover the effects of monetary policy and how it can impact ... Read Answer >>
  3. How do open market operations affect the overall economy?

    Understand how open market operations affect the overall economy. Learn how the Federal Reserve uses open market operation ... Read Answer >>
  4. 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 >>
  5. What is the relationship between inflation and interest rates?

    In general, as interest rates are lowered, more people are able to borrow more money, causing the economy to grow and inflation ... Read Answer >>
Hot Definitions
  1. Retirement Planning

    Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve ...
  2. Drawdown

    The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted ...
  3. Inverse Transaction

    A transaction that can cancel out a forward contract that has the same value date.
  4. Redemption

    The return of an investor's principal in a fixed income security, such as a preferred stock or bond; or the sale of units ...
  5. Solvency

    The ability of a company to meet its long-term financial obligations. Solvency is essential to staying in business, but a ...
  6. Dilution

    A reduction in the ownership percentage of a share of stock caused by the issuance of new stock. Dilution can also occur ...
Trading Center