- Mechanics of Monetary and Fiscal Policy
- What is Money?
- How is Money Created?
- Official Measures of Money: M1 and M2
- Demand and Supply of Money
- Fisher Effect
- What do Central Banks do?
- Tools for Implementing Monetary Policy
- Features of Effective Central Banks
- The Monetary Policy Transmission Mechanism
- Expansionary vs. Contractionary Monetary Policy
- Limitations of Monetary Policy
- Role of Fiscal Policy
- Tools of Fiscal Policy
- Fiscal Multiplier and Balanced Budget Multiplier
- Ricardian Equivalence
- Challenges in Implementing Fiscal Policy
- Expansionary Vs. Contractionary Fiscal Policy
- Combined Effects of Monetary and Fiscal Policy
Tools for Implementing Monetary Policy
The central bank of a country employs several tools to implement the country's chosen monetary policy. This article discusses the three primary policy tools used by central banks.
Open Market Operations
Under its open market operations, the central bank engages in buying and selling government securities to increase or decrease the monetary base.
- Open Market Purchases: The central bank buys government securities to increase the monetary base.
- Open Market Sales: The central bank sells government securities to decrease the monetary base.
In the US, open market operations are the most important tool used by the Fed, under which it buys and sells US government securities, especially the US Treasury bills. These trades are executed at the Open Market Desk of Federal Reserve Bank of New York.
Such open market operations permanently affect the monetary base in the country. However, sometimes there may be a need to change the monetary base only temporarily. In such case, the following types of transactions are used.
- Repurchase Agreements (Repos): Under repo transactions, the central bank (Fed in US) purchases securities with a promise that the seller will repurchase them on a specific date at a specific price. The time period is usually two weeks. A repo temporarily increases the money base.
- Reverse Repos: This is the reverse of a repo, where the central bank (Fed in US) sells securities with a promise that the buyer will sell them back on a specific date at a specific price. A reverse repo temporarily decreases the money base.
Open market operations have several advantages such as, it is in direct control of the central bank, can be conducted quickly, in any size they want, and are easily reversible.
This content is for paid members only.
Join our membership for lifelong unlimited access to all our data science learning content and resources.