Explain what is meant by 'Open market operation'.
Open market operation refers
to buying and selling of eligible securities by the Central Bank in the money
market and capital market. This is a tool to control inflationary &
deflationary situation in the market. The buying and selling of securities by
the Central Bank result in an increase or decrease in the cash resources of
the commercial banks. This in turn affects the credit creation of the
commercial banks.
For example:
In times of inflation, the Central Bank reduces the volume of credit
created by the banks, it sells eligible securities in the market. This results
in the movement of cash from Commercial Banks to Central Bank. As a result of
this the primary reserves of the banks fall. Hence, the capacity of the banks
to create credit will be contracted. Similarly, in
times of deflation, the Central Bank purchases the eligible securities from the
open market, this results in the movement of cash from the Central Bank to
commercial banks. As a result, the cash reserves in the hands of commercial
banks will increase. Hence, the capacity of the banks to expand credit
will be expanded.
Open market operation refers to buying and selling of eligible securities by the Central Bank in the money market and capital market. This is a tool to control inflationary & deflationary situation in the market. The buying and selling of securities by the Central Bank result in an increase or decrease in the cash resources of the commercial banks. This in turn affects the credit creation of the commercial banks.
For example: In times of inflation, the Central Bank reduces the volume of credit created by the banks, it sells eligible securities in the market. This results in the movement of cash from Commercial Banks to Central Bank. As a result of this the primary reserves of the banks fall. Hence, the capacity of the banks to create credit will be contracted. Similarly, in times of deflation, the Central Bank purchases the eligible securities from the open market, this results in the movement of cash from the Central Bank to commercial banks. As a result, the cash reserves in the hands of commercial banks will increase. Hence, the capacity of the banks to expand credit will be expanded.
