Open Market Operations

Open Market Operations

Open Market Operations, the measures by which the central bank controls the monetary system by buying and selling securities (chiefly Government bonds and Treasury bills) to joint-stock banks or the public.

In Britain open market operations in Treasury bills are conducted through a firm of discount brokers (the 'Special Buyer') on instructions from the Bank of England; operations in the gilt-edged market are conducted by a firm of stockbrokers (the 'Government Broker') on instructions from the Bank.

Such operations are one of the principal functions of the central bank and are undertaken to influence the level and the structure or pattern of interest rates in the financial markets. A corollary is that the supply of 'liquid' assets (on which the level of bank deposit money rests) is affected by open market operations (unless the authorities take action to prevent it). Thus sales of gilt-edged bonds by the authorities will depress their prices (and raise the yields of bonds): it will also reduce the cash reserves of the joint-stock banks as cash is exchanged for bonds (payment is usually made by an individual drawing a cheque on his account at a joint-stock bank; when the cheque is settled, deposits in the joint-stock bank and the joint-stock banks' deposits at the central bank are reduced). Secondary effects result from the attempts of the joint-stock hanks to restore the ratio of their assets held in liquid form, reduced by the outflow of cash: they may decrease advances to customers, or sell securities, so that the deposits held by the public will decrease and the ratio of liquid assets to deposits increase.

The Bank of England buys or sells gilt-edged securities almost every day in the money market with the general objective of making it work smoothly. Outside influences, such as the movement of 'hot money' from or to other countries, may temporarily upset the market. The Government itself in its day-to-day business also exerts a disturbing effect. For example, temporary gaps between Government spending and current receipts from taxation may give rise to short-term borrowing, and conversely. Continuous 'smoothing' purchases and sales are thus necessary to avoid erratic movements in interest rates.

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