Open Market Operations

Course Outline

Dictionary of Economics

Course (113 videos)

Open Market Operations

What are open market operations?

An open market operation is when the Federal Reserve buys and sells Treasury bills to change the amount of money in the economy. This practice is one of many tools the Fed can use to influence monetary policy.

The Fed determines how much to trade by targeting the federal funds rate. This rate, which is the overnight lending rate banks charge one other, theoretically influences other interest rates throughout the economy.

With us so far? Let’s sum up: open market operations change the money supply, which affects the supply of loans and changes interest rates, which affects the quantity of loans demanded.

Now there are two types of open market operations: expansionary and contractionary. We’ll go over each.

 

Expansionary Open Market Operations

 

When the Fed wants to increase the money supply and lower interest rates, they purchase Treasury bills from banks. This increases the supply of bank reserves.

What do the new reserves mean? Bank can make more loans! This stimulates the economy by making it easier to get a mortgage or start or grow a business. Increasing bank reserves also helps lower the federal funds rate because it decreases the opportunity cost of banks making loans to other banks.

Contractionary Open Market Operations

When the Fed wants to decrease the money supply and increase interest rates, they sell Treasury bills to banks. This decreases the supply of bank reserves.

Contractionary open market operations slow down an economy. That may seem counterintuitive, but they can help slow down inflation and correct for other distortions in the economy.

Open Market Operations After the Great Recession

While open market operations have historically been one of the important tools the Fed used to influence the economy, that changed after the 2008 financial crisis. We cover this in more detail in How the Fed Works: After the Great Recession.

Want to learn more about U.S. monetary policy and the Fed’s role? Check out our Macro section on Monetary Policy and the Federal Reserve.

Teacher Resources

Transcript

What are open market operations? Open market operations are one of the many tools the Federal Reserve Board has at its disposal to influence monetary policy. An open market operation is when the Fed buys and sells Treasury bills to change the amount of money in the economy. The Fed makes these trades with other banks, and decides how much to trade by targeting a particular interest rate known as the "federal funds rate," which theoretically affects other interest rates in the economy. So open market operations changes the money supply, which affects the supply of loans, and changes interest rates, which affects the quantity of loans demanded.

 

There are two types of open market operations -- expansionary and contractionary. An expansionary open market operation is when the Fed wants to increase the money supply and lower interest rates by purchasing Treasury bills from banks, thus increasing the supply of bank reserves. The new reserves would allow banks to make more loans, thus stimulating the economy, making it easier to start or expand new businesses, or easier to get a mortgage. This increase in bank reserves would also lower the opportunity cost of banks loaning those reserves out to other banks, and that, in turn, would lower the federal funds interest rate. A contractionary open market operation is when the Fed wants to decrease the money supply and increase interest rates by selling Treasury bills to banks, thus decreasing the supply of bank reserves.

 

You may be thinking, "Why would you ever want to slow down an economy?" Well, contractionary policies are usually used to slow down inflation, or correct for other distortions in the economy. Historically, open market operations were one of the most important tools the Fed had at its disposal to influence the economy. However, in more recent times, after the Great Recession, the Federal Reserve has relied more heavily on its other tools.

 

Subtitles


Turn captions on or off:

  1. If captions are available the (CC) icon will be visible on the player.
  2. To turn captions on, tap (CC).
  3. To turn captions off, tap (CC) again.
     

Select caption language: 

  1. Click the settings icon (⚙) at the bottom of the video screen.
  2. Click Subtitles/CC.
  3. Select a language.
     


 

Contribute Translations!

Join the team and help us provide world-class economics education to everyone, everywhere for free! You can also reach out to us at support@mru.org for more info.


Submit subtitles

 

 

Accessibility

We aim to make our content accessible to users around the world with varying needs and circumstances.

Currently we provide:


Are we missing something? Please let us know at support@mru.org

Download

Creative Commons

Creative Commons License

This work is licensed under a Creative Commons Attribution-NoDerivatives 4.0 International License.
The third party material as seen in this video is subject to third party copyright and is used here pursuant
to the fair use doctrine as stipulated in Section 107 of the Copyright Act. We grant no rights and make no
warranties with regard to the third party material depicted in the video and your use of this video may
require additional clearances and licenses. We advise consulting with clearance counsel before relying
on the fair use doctrine.