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Open Market
Operations
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The Fed
implements monetary policy
by directly influencing short term interest rates. It does this
through
its control of the interbank lending rate, also known as the Fed funds
rate. This involves supplying just enough reserves to meet the
demand
at its target rate.
The Objective
The Fed supplies
reserves to banks
through its open market operations (OMO) and its discount window
lending.
Discount lending now plays a minor role. The principal tool is
OMO
in which the Fed buys or sells government securities in the secondary
market
to add or drain banking system reserves.
Normally the
objective of OMO is not
to effect a net change in reserves; rather it is to counter variations
in the total. These variations are caused mainly by changes in
the
Treasury’s cash balances at the Fed, checking system float, foreign
central
bank transactions, and net cash flows in or out of banks. However
as net bank lending varies, the aggregate demand for reserves will vary
and require the Fed to adjust the total in order to maintain control of
the Fed funds rate.
Basic Operations
OMO is executed by
the Trading Desk
of the Federal Reserve Bank of New York, on behalf of the entire
Federal
Reserve System. The Desk buys securities from government
securities
dealers who have an established trading relationship with the
Fed.
It pays for the securities by sending funds to the dealer's account at
its clearing bank, as it takes delivery of the securities at the
Fed.
This action adds reserves to the banking system. Conversely, when
the Fed sells securities to a dealer, it delivers the securities and
the
account of the dealer is debited. This action drains reserves
from
the banking system.
Types of Transactions
The Trading Desk most
often engages
in short-term repurchase agreements (RPs) which are used in situations
that call for temporary additions to bank reserves. With RPs, the
Desk buys securities from the dealers, who agree to repurchase them at
a specified date and at a specified price. When the RPs mature,
the
added reserves are automatically drained.
If there is a temporary
need to drain
reserves, the Trading Desk executes reverse RPs with dealers in
Treasuries.
These transactions involve a contract for immediate sale of Treasury
bills
to the dealer, with a matching contract for later purchase from the
dealer.
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