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It is important to understand
what “open market operations” are and how it works with regards to the Federal
Reserve. The open market operations (OMOs) are a system, where securities are
bought or sold from other banks by the Federal Reserve. These securities are
either mortgage-backed or treasury notes. It is important to know why Federal
Reserve involves in such kind of activity, and there is one primary reason to
do so; it helps Federal Reserve to raise as well as lower the level of interest
rates. For instance, when Federal Reserve wants to raise the interest rate,
then securities are sold to the member banks. This policy is given a particular
name, which is called a contractionary monetary policy. The main purpose of
doing so is to make inflation a bit slow so that economic growth can be
stabilized. However, when the purpose is to lower the level of interest rates,
the securities are bought by Federal Reserve from the banks. When these
securities are purchased as OMOs, this policy is named as expansionary monetary
policy. The policy is adopted for stimulation of economic growth so that the
unemployment rate can be lowered
The Federal Reserve is the
central bank of the United States, so they have to involve in different
activities to handle their monetary policy. OMOs are one of the methods to
manage central monetary policy so that the Federal Reserve can have more
control on things. It is important to mention here that the Federal Reserve
serves two kinds of purposes with the help of OMOs, and these purposes can be
short term or long term. These purposes are served with the following types of
policies:
·
Permanent: The
Federal Reserve may sale or even purchases securities with an outright approach
and the purpose of this sale is purchase is associated with the System Open
Market Account (SOMA), which is one of the portfolios of the Federal Reserve.
The Federal Reserve has to deal with such OMOs so that they can manage their
balance sheet on a long term basis. If a financial crisis is about to happen,
or when a financial crisis has gone, the role of OMOs is crucial in both
situations. These permanent OMOs are useful for the Federal Reserve as they can
adjust holdings of their securities so that downward and long term pressure is
put on the interest rate, as well as it is done to get more accommodative
financial conditions. The policies of the FOMC are being applied with the
current permanent OMOs
·
Temporary
OMOs: It is important to know that there are various
transitory reserve needs, which are handled with the help of temporary OMOs.
Two kinds of agreements are made with these temporary OMOs; first is called
reverse repurchase agreements and the second is called repurchase agreements.
In repurchase agreements, security is bought by the trading desk and an
agreement is made that security will be resold in the future. The repurchase
agreement is actually a collateralized loan or a method to get economic
equivalent by the Federal Reserve. In reverse repurchase agreements, security
is sold by the trading desk, and an agreement is made that this particular
security will be repurchased by the Federal Reserve in the future. FOMC has set
a target range for the federal funds rate, and the Federal Reserve is able to
handle that funds rate with the help of reverse repurchase agreements
After looking at both the
Permanent and Temporary OMOs, it is essential to understand that both OMOs are
critical for the Federal Reserve on a short and long term basis because they
are extremely helpful in managing the balance sheet. It is crucial for the
Federal Reserve to come up with some policies so that normalization of the
monetary policy is achieved accordingly, and agreements made under the
permanent and temporary OMOs are vital to keeping things on the right track.
The Federal Reserve used to
publish reports on a regular basis for annual results with regards to Open
Market Operations. Each year's report has certain elements to be implemented.
For instance, as per the 2017 report for the implementation of the Monetary
Policy, it was agreed by the Board of Governors of the Federal Reserve System
that 1.25% would be the interest rate, which would be paid for excess as well
as required reserves. In the same year, Open Market Desk of the Federal Reserve
Bank of New York was allowed to direct as well as authorize to execute
different kinds of transactions that are relevant to the System Open Market
Account. In addition to that, the primary credit rate established by the Board
of Governors of the Federal Reserve System was 1.75%
It is vital for the Federal
Reserve to set a good rate for the federal funds rate so that OMOs are
effectively managed for better performance. As per the report, there was a zero
increase in the federal funds rate on 31st Oct, whereas the decrease was 25,
which means that the overall percentage level was 1.50-1.75%. This percentage
was 2.00-2.25% in the month of August 2019. When the federal funds rate for the
year 2018 is observed as per the data, it was evident that the federal funds
rate percentage was 2.25-2.50 in December 2018, whereas this rate was
1.75-2.00% in the month of June. In 2018, the overall rate observed an increase
in its percentage till December 2018. Same was the case with 2017 stats, as the
increase for the federal funds rate was also observed in 2017
References of Open Market Operations by Federal Reserve
AMADEO, K. (2019). Open Market Operations.
Retrieved November 14, 2019, from
https://www.thebalance.com/open-market-operations-3306121
FEDERAL RESERVE SYSTEM. (2019). Credit and Liquidity Programs and the
Balance Sheet. Retrieved November 14, 2019, from
https://www.federalreserve.gov/monetarypolicy/bst_openmarketops.htm
Federalreserve.gov. (2019). Open Market Operations. Retrieved
November 14, 2019, from
https://www.federalreserve.gov/monetarypolicy/openmarket.htm
The Federal Reserve. (2017). Implementation Note issued November 1, 2017. Retrieved November 14, 2019, from https://www.federalreserve.gov/newsevents/pressreleases/monetary20171101a1.htm
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