The term 'Open Market Operations (OMO)' is included in the Accounting edition of the Financial Dictionary. Get your copy on Amazon in Kindle, Paperback or Audio edition. Choose your edition here...
Open Market Operations are also called by their acronym OMO. These describe both the purchasing and selling of open market-based government securities. The Federal Reserve central bank of the United States has a committee which engages in these transactions with the goal of expanding or contracting the total quantity of money flowing through the banking system.
When the Fed buys up instruments, it forces money into the banking system to stimulate growth. When it sells its various securities, this has the opposite effect and contracts the economy. The idea behind the Federal Reserve’s thinking with this technique is to tweak through manipulating the federal funds rate. This rate represents the price for which the banks will loan money to each other.
This Open Market Operation proves to be the most frequently deployed and highly flexible tool from the toolkit of the Federal Reserve. It permits them to both control and implement their monetary policy for America. They also work with the reserve requirements for the banks and the discount rate. While they have all three tools at their disposal, the buying and selling of government securities proves to be their favorite and also most often deployed tool. This permits them to precisely control the amount of bank reserve balances. It assists the Federal Reserve in decreasing or increasing the short-term interest rates as they deem to be appropriate for any given time.
The Federal Reserve committee which determines the monetary policy is called the FOMC Federal Open Market Committee. They carry out this monetary policy through actually setting the target for the federal funds interest rate and also by implementing their Open Market Operations, along with manipulating the reserve requirement and discount rate strategies to get the federal funds rate to their desired levels. This fed funds rate turns out to be incredibly important for them to finely control since it impacts practically every other interest rate found in the United States today. Among these are the prime rate, car loan rates, and home loan mortgage rates. Only the London-based LIBOR is more important today.
When the FOMC is attempting to attain a desired federal funds rate, they first fall back on the Open Market Operations. They carry out either the contractionary or expansionary monetary policy to achieve their desired movement and ultimate ends.
When the Fed sets its sites on expanding the economy this way, they want an expansionary policy. They need to reduce the fed funds rate in order to facilitate this goal. They will buy government securities off of private bond dealers to deposit funds into the accounts for the financial institutions, entities, and investors who sold them the government bonds. These deposits then became a component of the commercial bank held-cash on account with the Federal Reserve. It grows the money supply available to commercial banks for their various lending operations. It is these commercial banks which seek to loan out their cash reserves. To do this, they will lower their interest rates to bring in more customers.
The Fed also occasionally has moments when it seeks to cool off an overheating economy in the U.S.A. To do this they will begin their contractionary monetary policy and seek to boost the federal funds rate. In practice, this involves them selling off their seemingly limitless supply of government securities to the financial institutions and banks. It reduces the amount of money the commercial banks have left to loan out. This makes the cost of money more expensive and so boosts the associated interest rates, including the federal funds rate too.