Question

Open Market Operations a) What is an open market operation by a central bank? b) What is the difference between an open market operation and a discount window operation by a central bank? c) Why does a rise in the level of government bond interest rates reduce the amount of private borrowing from commercial banks and vice-versa? d) Suppose that the economy is in a deep recession – unemployment is very high because the level of aggregate demand is very low. Should the central bank buy or sell bonds in order to reduce interest rates and increase aggregate demand? Why?

Answer 1

Answer a ) The open market operation means that sale and purchase of the government securities and bonds by the centeral bank in order to regulate the supply of money in the market area. The Central bank operate open market operation with the help of commercial bank as it does not deal with general public The open m arket operation has affected the bank deposits , reserves and there ability to create credit to the government.The participants of open market operations are people, commercial bank and other financial institutions. It is most common tool used by central bank in order to check supply of money.

b)Difference between open market operation and discount window operation are :

• in the open market operation fed buys or sell government securities in order to increase the money supply in an economy where as in case of discount window the fed provides loan to the commercial bank and charge interest rate from them.
• In the open market operation bonds are deal and selling and purchasing of bond affect the supply of money where as in case of discount window are dealt with the interest rate of the loan.
• open market operation is more used by the central bank as compare to discount window.

c )As when there was rise in an interest rate of the government bond resulted in an increase in the supply of money in an economy. As there are less private borrowings and consumption are quite less and inappropriate. As interest rate or fixed income from bonds has been decreased which resulted in a private borrowings has been increased.

d) The federal bank should buy bonds from the commercial bank than the interest rate has been reduced as well as money supply in an economy has been increased which result economy has been gained a lot from it.   This shows that in order to increase money supply economy also increase it consumption and aggregate demand.