Open market operations are the tecniques used by the Federal Reserve, and other monetary authorities, to modify the money supply, in other words, to modify the amount of money in circulation in the economy.
These operations consist on either buying or selling government bonds, depending on whether the aim is to increase or decrease the money supply, respectively. These market operations affect interest rates, which function as the price of money.
- When buying bonds, the money paid for them is put into circulation. Therefore, if the amount of money in circulation increases, the price of money will react negatively and decrease. Interest rates will be lower, it will be cheaper to obtain funding and investing becomes less profitable. In this scenario, the money supply will boost.
- When selling bonds, the effects are exactly the oppostite. The supply of money decreases and interest rates go up.