Question

Fed uses open market operations to influence the money supply. Explain both an open market purchase and an open market sale.

Answer 1

The Federal Reserve of United States regulate the monetary policy of the coun try for the growth of its economy by determining the money supply which helps in controlling the inflation. The Federal Reserve buys and sells government securities and bonds which decides whether to increase or decrease the size and rate of money supply in the economy. The process of buying and selling government securities to regulate the money supply in the form of treasury bills, notes and bonds are called as open market operations.

Federal reserve buys securities from coomercial banks to increase the money supply in the economy by increasing their reserves. Banks use the funds acquired by selling the securities as loan which are sanctioned for persona and commercial purposes. The interest rates of these loans are lower with the availability of more money in the economy which drwas more people for for cheaper capital which inturn increase the investment rate in the market increasing the money supply in the market and boosting the economy decreasing unemployment.

Federal reserve sells securities to banks when it wants to reduce the money supply in the market to controll inflation and economic growth.Selling securities to the commercial banks reduce their reserves which in turn will affect in their loans and investments. Limited reserve means few loans with higher interest which in turn will draw fewer borrowers and reduced investment.