Question

What are open market operations? What is their effect on availability of credit?

Answer 1

Open market operations refers to buying and selling of the Government securities in the market to either suck or pump liquidity in the economy.In open market operations the central banks mainly sell and buy government securities to control the money available with bank, when the central bank decides to suck out the liquidity in the banking sector they introduce more bonds, and when they want to liquefy the banks with more money they start buying back the government securities.

Based on the bond availability or price the banks cost to buy money from other banks reserve will be affected thus it effects the interest rate of advances and deposits in banking system has a whole.

Assume if the Central bank sees that more money is available with banks and the rate of interest for credits is getting low due to excess money available in the sector and competition among peers, then money will be loosed out to economy, and inflation peeks up.

Seeing this and anticipating future impact Central bank will formulate policy and they introduce government securities at better rates for the banks to buy and the money from banks will be sent to central bank now the banks have less cash and also to buy from other banks the cost will be proportional to the government bond rates so there will be slow increase in the rate to buy money for lending thus it boosts demand for money and deposit rate will be increased and since cost of the deposits increased the rate at which lending happens also increases. This how the credit is controlled using open market operations.