Applications of Open market operation:
An open market operation is a kind of activity performed by the central bank to sale and purchase the govt. bonds which in directly contract and expands the money supply. Basically it is the tool which affects the federal funds rate it increases or decreases it. It is the most important tool of monetary policy. When the central bank purchases the securities it enhances the reserves of the commercial bank and in this way the can lend more money. By this act the interest rate goes down and which encourage the investment and the reverse case happened in the sale of securities. Pros and Cons of OMO’s:
1. It is very easy to implement and evident shown very easily. 2. It can be easily reversed if any error done regarding policy. 3. They are very flexible and precise and can be easily implemented and the results are shown very fastly, because it does not take very much time. 4. If the money market is not developed, the central bank will not be able to exert full control over the bank reserves. 5. If the commercial banks have any excess reserves with them and they resort to easy lending policy, the sale of government securities will not have the desired results of reducing the cash reserves of those respective commercial banks. Circulation of bank credit should always remain unchanged. Discount Lending:
The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility--the discount window. The Federal Reserve Banks offer three discount window programs to depository institutions: 1. Primary credit (Short-term ,usually overnight)
2. secondary credit (short-term liquidity needs)
3. Seasonal credit (intra-year Fluctuation)
Each with its own interest rate. All discount window loans are fully secured. If the central bank increases the discount rate the banks...