ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -Open market operations work by selling and buying government securities by the central bank of a nation. To increase the money supply, the central bank buys back securities, while to reduce the money supply it sells securities to the commercial banks.

Detailed explanation-2: -When the Fed buys securities on the open market, cash is transferred to these banks, increasing the nation’s money supply. Conversely, when the Fed sells government securities, these banks have less cash available to them – a decrease in the nation’s money supply.

Detailed explanation-3: -Open market operations allow the Federal Reserve (or the central banks in other countries) to prevent price inflation or deflation without directly interfering in the market economy. Instead of using regulations to control lending, the Fed can simply raise or lower the cost of borrowing money.

Detailed explanation-4: -By buying or selling bonds, bills, and other financial instruments in the open market, a central bank can expand or contract the amount of reserves in the banking system and can ultimately influence the country’s money supply.

Detailed explanation-5: -The Fed purchases securities from a bank (or securities dealer) and pays for the securities by adding a credit to the bank’s reserve (or to the dealer’s account) for the amount purchased.