Open Market Operations

Open Market Operations refers to buying and selling of bonds issued by the Government in the open market. This purchase and sale is entrusted to the Central bank on behalf of the Government. When RBI buys a Government bond in the open market, it pays for it by giving a cheque. This cheque increases the total amount of reserves in the economy and thus increases the money supply. Selling of a bond by RBI (to private individuals or institutions) leads to reduction in quantity of reserves and hence the money supply.

There are two types of open market operations: outright and repo. Outright
open market operations are permanent in nature: when the central bank buys
these securities (thus injecting money into the system), it is without any promise to sell them later. Similarly, when the central bank sells these securities (thus withdrawing money from the system), it is without any promise to buy them later. As a result, the injection/absorption of the money is of permanent nature.

Open market operations refer to the selling and purchasing of the treasury bills and government securities by the central bank of any country, in order to regulate money supply in the economy.

It is one of the most important ways of monetary control that is exercised by the central banks. Under this system, the central bank sells securities in the market when it wants to reduce the money supply in the market. It is done to increase interest rates. This policy is also known as contractionary monetary policy.

Similarly, when the central bank wants to increase the money supply in the market it will purchase securities from the market, this step is taken to reduce the rate of interest and also help in the economic growth of the country. This policy is known as the expansionary monetary policy.

How do Open Market Operations take place?

Open market operations are carried out by the central bank in association with the commercial banks. For conducting such operations, there is no involvement of the public.

Government bonds are mostly bought by commercial banks, financial institutions, high net worth individuals, large business corporations. All these entities maintain accounts with the bank, and whenever these entities purchase bonds, the amount gets transferred to the central bank.

Thus, it can be said that open market operations have an impact on the deposits and reserves of the bank and also plays a role in their ability to provide credit. When a central bank wants to reduce the availability of money to the public, it will sell government bonds and securities with the help of commercial banks.

This step reduces the money supply in the economy and restricts banks to offer credit to individuals. It impacts both the supply and demand of the credit.

Similarly, at times when the liquidity conditions are tight, the central bank buys back the securities which gives the commercial banks and public easy access to the credit facilities that help in injecting liquidity into the system and establishing the market.

Example-

Central banks conduct open market operations in order to regulate the money supply in the economy. For example, in India, open market operations are undertaken by the Reserve Bank of India or RBI.