Management Notes

Reference Notes for Management

Open Market Operation is

Open Market Operation is

    1. Buying and selling of government securities
    2. Sale of government securities
    3. Buying and selling of government cheques
    4. All of the above

Correct Answer: Buying and selling of government securities

 Answer Explanation

In an open market operation (OMO), the central bank buys and sells government securities. This process involves the central bank buying government securities from the financial markets, injecting money into the banking system, whereas when the central bank sells government securities, it withdraws money from the banking system.

The transactions are conducted on the open market with authorized participants, such as commercial banks and other financial institutions. Central banks use OMOs as a key monetary policy tool to influence the availability of money, interest rates, and credit.

By buying government securities, the central bank increases the monetary base, which leads to an expansion of the money supply as commercial banks create new loans and deposits. Increased liquidity stimulates economic growth by encouraging borrowing and spending.

Why the other options are not correct

b. Sale of government securities

The central bank does sell government securities during OMOs, but it is only one part of the open market operation overall. A reduction in the monetary base may result in a contraction of the money supply and a potential tightening of credit if government securities are sold.

Option (a) provides a more comprehensive and accurate representation of an OMO, which involves both buying and selling government securities.

c. Buying and selling of government cheques:

Government cheques are not a typical component of open market operations. Government securities, including Treasury Bills and Bonds, are the primary component of OMOs. A central bank’s open market operations are the buying and selling of government securities, not cheques, to borrow money. Government securities, not cheques, are the instruments by which the government borrows money.

d. All of the above:

It is correct that open market operations involve both buying and selling government securities, but the term “government checks” mentioned in option (c) does not apply to OMOs.so, option d is incorrect.

Conclusion

Open Market Operations are crucial to central banks’ implementation of monetary policy. Central banks can influence interest rates, control the money supply, and manage credit conditions in the economy by buying and selling government securities on the open market.

It takes careful consideration of economic conditions and policy objectives to determine the appropriate use of open market operations for maintaining price stability, promoting economic growth, and ensuring financial stability.

It is therefore essential for central banks to conduct monetary policy through open market operations. When the central bank purchases government securities, it increases the money supply and expands credit, whereas when it sells government securities, it reduces the money supply and tightens credit.

By maintaining a stable and sustainable financial environment, central banks can adapt to changing economic conditions with this flexibility.

When the Central Bank intends to expand the credit, it should

Bibisha Shiwakoti

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