Question

3.What are the reasons behind why the Federal Reserve uses U.S. Treasury securities for open market operations?

Answer 1

The Fed uses open market operations as its primary tool to influence the supply of bank reserves. This tool consists of Federal Reserve purchases and sales of financial instruments, usually securities issued by the U.S. Treasury, Federal agencies and government-sponsored enterprises. Open market operations are carried out by the Domestic Trading Desk of the Federal Reserve Bank of New York under direction from the FOMC. The transactions are undertaken with primary dealers.

When the Fed wants to increase reserves, it buys securities and pays for them by making a deposit to the account maintained at the Fed by the primary dealer’s bank. When the Fed wants to reduce reserves, it sells securities and collects from those accounts. Most days, the Fed does not want to increase or decrease reserves permanently, so it usually engages in transactions reversed within several days. By trading securities, the Fed influences the amount of bank reserves, which affects the federal funds rate, or the overnight lending rate at which banks borrow reserves from each other.

Open market operations refers to a process by which a division of the Federal Reserve buys and sells government securities to set the money supply. If the FOMC wants to increase the money supply in the economy it will buy securities. Conversely, if the FOMC wants to decrease the money supply, it will sell securities.

Stepwise process by Federal Reserve system:

The Federal Reserve System uses open market operations as their primary monetary policy tool for controlling the money supply and interest rates. The process is reality easy to implement and extremely effective. The process works like this:

So to summarize the reasons behind why the Federal Reserve uses U.S. Treasury securities for open market operations are:

1. INFLATION AND INTEREST RATE TARGETING

The significant target of this is interest rates and inflation. The focal endeavors to keep up expansion at a specific range with the goal that the economy of the nation becomes at a steady and enduring pace. This is taken by the national bank has a nearby connection with loan costs. At the point when the national bank offers securities and government bonds to different banks and the open it influences the free market activity of credit too.

2 – MONEY SUPPLY TARGETING

The central bank may target and control the money supply in the economy. The central bank tries to maintain adequate liquidity in the banking system when it feels there is high liquidity it tries to suck the excess liquidity by selling bonds and vice-versa.