DEFINITION: The phrase “open market operations (OMOs)” refers to the purchase and sale of securities on the open market by the US Federal Reserve (“the Fed”).
The Fed undertakes OMOs to control the amount of money held in reserve by American banks collectively.
The Fed buys Treasury securities when it wishes to increase the money supply and sells them when it wishes to decrease the money supply.
Open market operations enable the Fed to fine-tune the federal funds rate. The Fed’s adjustments then ripple through various short-term and long-term interest rates, as well as foreign exchange rates.
For this reason, OMOs create the potential for shifts in the volume of money and credit accessible within the economy, which, in turn, impacts a variety of significant economic phenomena, including commodities and services pricing, output and unemployment rates, and similar factors.
ETYMOLOGY: The phrase “open market operations” seems to have been introduced around 1923, along with the practice it describes.
The English adjective “open” derives from Middle and Old English words with the identical form and meaning. The Old English word is akin to Old High German offan, also meaning “open.”
The English noun “market” (used here adjectivally) derives, via Middle English and Old North French, from Latin mercātus, mercātūs, meaning “trade,” “traffic,” or “business,” as well as the place where the trade or business occurs (i.e., a “marketplace”).
Mercātus, in turn, is connected to the deponent verb mercor, mercari, meaning “to trade” or “to traffic in,” as well as the noun merx, mercis, meaning “goods” or “merchandise.”
The English noun “operation” derives, via Middle English operacioun, from Middle French opération, which, in turn, derives from the Latin noun operatio, operationis, with a similar meaning.
Operatio, for its part,is connected with the past participle operātus of the deponent verb operor, operari, meaning “to work,” “to labor,” or “to be busy.”
Operatio may also be connected directly with the noun opus, operis, meaning “work,” “labor,” or “a finished piece of work.”
USAGE: To grasp the concept of open market operations, it is first of all essential to understand how the Federal Reserve, the United States’s central bank, puts the government’s monetary policy into action.
The Fed’s ultimate goal is to preserve the stability of the US economy and to prevent out-of-control price inflation or deflation. The Fed’s Board of Governors is the entity tasked with achieving these aims and thus with determining the federal funds rate target.
The federal funds rate is the interest rate at which depository institutions make short-term loans to each other.
This ongoing circulation of funds accomplishes two purposes:
- It allows banks to generate earnings on surplus funds held in their Federal Reserve balances
- It allows banks to maintain the reserves necessary to satisfy customer demand
The federal funds rate functions as a benchmark, which exerts influence over a wide array of other interest rates, ranging from savings deposit rates to home mortgage rates to credit card rates and more.
In summary, open market operations represent one of the principal instruments by means of which the Fed maintains the federal funds rate at or near its predetermined target.