Monetary Policy and Investment Opportunities

By Laura S. Nowak | Go to book overview

2
Federal Reserve Open Market Operations and the Government Securities Market

The major tool employed by the Federal Reserve System today to maintain price stability and to promote economic growth is open market operations. These operations, carried out by the New York Federal Reserve Bank, consist of buying and selling Treasury securities. The Fed's open market operations directly influence the banking system's ability to make loans. The ability to make loans, that is, the availability of credit, is a major determinant of the nation's money supply and the level of interest rates.

The Fed's purchases and sales have a direct effect on the banking system because the payments pass through the banking system. When the Fed buys or sells, its purpose is either to maintain financial stability or to effect a change in the economy. Determining whether the Fed's actions are a result of a change in policy or whether they are simply an effort to maintain stability in the marketplace can be very difficult, but it can be very lucrative as well.

When the Fed buys securities, it deals directly with a selected group of primary dealers who participate on their own behalf or on behalf of their customers, and then trade with other dealers, brokers, banks, as well as nonbank customers. All payments for securities are deposited or wired to the dealer's or customer's banks. When the Fed buys securities, it pays for them by transferring funds to the dealers' banks. Since the funds are not being transferred from one bank to another, they are not subtracted from any other bank's account. Instead, the transfer from the Fed constitutes a net increase in deposits (and reserves) in the banking system. When the Fed buys, it increases its own inventory of securities and injects money

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