14.2 Open Market Operations #Notebook

14.2 Open Market Operations #Notebook

The Fed influences the MS via the MB, and control their monetary liabilities, MB, by buying and selling securities, called open market operations. If a central bank wants to increase the MB, it need only to buy securities. 

If the Fed bought a $10,000 bond from a bank, the banking system would lose $10,000 worth of securities but gain $10,000 of reserves. 

The central bank would gain the asset of securities by creating the liability of reserves. The central bank’s liabilities are everyone else’s assets. 

The MB increases by the amount of the purchase because either C (Currency in circulation) or R (Reserves) increases by the amount of the purchase. 

Notice!

*Currency in circulation means cash (like FRN) no longer in the central bank. 

*An IOU in the hands of its maker is no liability.

*Cash in the hands of its issuer is not a liability. 

*Although the money existed physically before people sold his bond, it did not exist economically as money until it left its creator, the central bank. 

However, if the transaction were reversed and someone bought a bond from the central bank with currency, the notes he paid would cease to be money, and currency in circulation would decrease.

When the central bank sells an asset, the MB shrinks because C or R decreases along with the central bank’s securities holdings, and banks or the nonbank public own more securities but less currency or reserves.

The central bank can also control the monetary base (MB) by making loans to banks and receiving their loan repayments. A loan increases the MB and a repayment decreases it.

Reference

Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation.  Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.