Question

What is the primary purpose of Open Market Operations in monetary policy?

a) To regulate the discount rate
b) To raise the reserve ratio
c) To buy or sell government bonds to affect the money supply
d) To provide short-term loans to commercial banks

Answer 1

The primary purpose of Open Market Operations is to buy or sell government bonds to affect the money supply, to influence the level of interest rates and the amount of bank reserves, particularly target the federal funds rate. The correct option is C.

Step-by-step explanation:

The primary purpose of Open Market Operations (OMO) in monetary policy is to buy or sell government bonds to affect the money supply. This action by a central bank, such as the Federal Reserve in the United States, directly influences the quantity of bank reserves and consequently the level of interest rates. The federal funds rate, a key short-term interest rate that reflects credit conditions in financial markets, is the specific interest rate targeted through these operations. When the central bank buys government bonds, it injects money into the banking system, which can lower interest rates and increase the money supply. Conversely, selling bonds takes money out of circulation and can lead to higher interest rates and a reduced money supply.

The two other tools commonly used for monetary policy include modifying reserve requirements (the minimum amount of reserves banks must hold) and adjusting the discount rate (the interest rate charged by the central bank for loans to commercial banks). These tools work alongside OMO to regulate the economy's liquidity and stabilize prices by controlling inflation and fostering economic growth.