The Federal Reserve believes that a certain rate of interest on Federal Funds is associated with...

The Federal Reserve believes that a certain rate of interest on Federal Funds is associated with price stability (which is 2% rate of inflation). However, the Federal Funds rate tends to fluctuate with the changes in the demand for federal funds by the banking system. Hence, to maintain the Federal Funds rate at the desired rate or to raise it or lower it to a new rate the Federal Reserve System undertake open market operations, or few other measures.

What is the difference between dynamic open market operations and defensive open market operations?

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Expert Solution

The difference between Dynamic and Defensive Open Market operations are listed below

1. Dynamic Open Market Operations are long term strategies which are implemented to increase or decrease the supply of currency in the country, which results in a permanent change. Whereas Defensive Open Market operations are implemented to offset seasonal, temporary or maybe accidental changes in supply of currency in the country; it is done in anticipation or as a response to a market event.

2. Dynamic Open market Operations are intended to change the Reserve level or Monetary base, whereas Defensive are intended to offset changes in other factors that affect reserves and the monetary base, such as Treasury deposits with the Fed or changes in float.

3.Dynamic Open market Operations are done through sale and purchase transactions directed by FOMC, whereas Defensive Open market Operations are carries out through Repo( Repuchase ) agreement (n which the Fed lends money to commercial banks) , in order to increase supply of currency and Reverse Repo agreement (in which the banks purchase securities from the Fed) in order to reduce the currency supply.

Rahul Sunny answered 1 year ago

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