Financial Markets and Institutions (2-downloads)

Open market operations, the central bank’s purchase or sale of bonds in the

open market, are the most important monetary policy tool because they are the

primary determinant of changes in reserves in the banking system and interest

rates. To see how they work, let’s use T-accounts to examine what happens when

the Fed conducts an open market purchase in which $100 of bonds are bought

from the public.

When the person or corporation that sells the $100 of bonds to the Fed

deposits the Fed’s check in the local bank, the nonbank public’s T-account after

this transaction is

When the bank receives the check, it credits the depositor’s account with the

$100 and then deposits the check in its account with the Fed, thereby adding to its

reserves. The banking system’s T-account becomes