The Basics
- Simple definition: The central bank buys or sells government securities to control the money supply and interest rates.
- Core idea: The primary tool for implementing monetary policy is day-to-day.
- Think of it as: The central bank’s faucet – opening it adds money, closing it removes money.
What It Actually Means
When a central bank buys government bonds from commercial banks, it pays by crediting their reserves – increasing the money supply, lowering interest rates. When it sells bonds, banks pay, reducing reserves – decreasing money supply, raising rates. Open market operations are flexible, reversible, and conducted daily in most countries. They’re the main way central banks keep short-term rates at target.
Example
If the State Bank of Pakistan wants to inject liquidity, it buys government securities from banks. Banks now have more rupees to lend, pushing market rates down. To absorb excess liquidity and raise rates, it sells securities.
Why It Matters (2026)
With large liquidity from previous easing, central banks now use reverse operations (selling securities) to drain money and fight inflation. Understanding OMOs helps interpret why interest rates move.
See also
Monetary Policy • Interest Rates • Reserve Requirements • Discount Rate • Liquidity Management
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