Open Market Operations (OMO)

Definition

The term open market operations refers to the purchase and sale of government securities in order to increase or decrease the money supply. Open market operations are one of the three tools the Federal Reserve can use to reach or maintain the objectives of its monetary policy.

Explanation

Also known as OMOs, open market operations involve the purchase and sale of government securities by a central bank. OMO is one of the three tools the Federal Reserve can use to achieve its monetary policy objectives. Generally, the purchase of securities (primarily Treasury bonds) injects money into the banking system, thereby stimulating growth in the economy. Conversely, selling securities lowers the money supply, thereby slowing down an overheating economy.

Open market operations are subdivided into two tactics:

  • Temporary OMOs: usually deployed to address reserve needs in a transitory state. Implementing this policy involves short-term repurchase and reverse repurchase agreements, which are used to temporarily increase or decrease the size of the Federal Reserve's System Open Market Account (SOMA) and influence the direction of the federal funds market.
  • Permanent OMOs: usually deployed to adjust for longer-term factors affecting the Federal Reserve's balance sheet, or the amount of currency in circulation. Permanent OMOs involve the sale or purchase of securities (again, typically Treasury bonds) in order to increase or decrease SOMA.

The purchase and sale of government securities provides the Federal Reserve with a mechanism to control the reserve balances held by banks, which will lead to an increase or decrease in short-term interest rates.

Related Terms

reserve requirement, monetary policy, contractionary monetary policy, expansionary monetary policy, Federal Funds rate, fiscal policy