Download open market operations

OPEN MARKET
OPERATIONS
Changing the money supply to change interest rates.
GENERALLY SPEAKING
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INCREASING the money supply will DECREASE
interest rates since there is more money in the
market to be loaned out.
DECREASING the money supply will INCREASE
interest rates since there is less money in the market
to loan out
VISUAL
MONEY
SUPPLY
INTEREST
RATES
r
MONEY
SUPPLY
INTEREST
RATES
r
The Federal Funds Rate
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
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When banks need to borrow reserves from other banks they
go to the Fed Funds Market. Banks offer their excess funds
to other banks for overnight lending to meet their reserve
requirements.
The Federal Reserve does not decree this interest rate, but
they use bonds to add or take from this pool of money. This
causes interest rates in the fund to go up or down.
In this way they have the power to change the FFR at any
given time.
This is the most basic interest rate, and ALL others are
derived from it. Mortgages, credit cards, and car loan rates
all depend on the FFR.
DAILY ACTIVITY


The FED keeps constant tabs on the up to the minute
FFR. They make sure that it trades within a given
range over a specified time period, until the FOMC
changes its policy stance.
LINK: http://www.newyorkfed.org/charts/ff/
Note how much the Fed Funds Rate has changed over the last decade. Lows indicate
recessions and slower economic output. Increases indicate growth in the economy, the
Fed will raise rates to keep inflation in check. What does the recent trend tell us
about the depth of the current recession?
DIAGRAM FOR OPEN MARKET OPERATIONS:
•The diagram below shows how an open market PURCHASE of $1 Billion
dollars in government bonds affects bank reserves. An open market SALE
would be just the opposite.
FEDERAL
RESERVE
SYSTEM
(Money credit)
COMMERCIAL
BANK
(Bond to Fed)
Federal Reserve Assets:
$ 1,000,000,000 cash or credit
Bank Assets Before Purchase:
--$1, 000,000,000 Government Bond
Excess Reserves Before Purchase:
--$0, banks has no excess reserves
AFTER PURCHASE BY FED:
Federal Reserve Assets:
$1,000,000,000 Government Bond
Bank Assets After Purchase
$1,000,000,000 in Excess Reserves
•The bank can now loan out these reserves to customers seeking loans.
As you can see, the Fed just “created” $1 billion dollars in loanable funds for the
banking system, thus increasing the money supply and pushing interest rates
DOWN!
•It is in this way that the FED routinely adds and subtracts money from the total
amount of reserves in the banking system. Since bank deposits can easily
become money, changing their reserves changes the money supply.
•The FED can easily reverse its decision when needed by making the opposite
move in the BOND MARKET.