Open market operations
This is the most important tool of monetary policy in most countries today. Open market operations means the buying and selling of government securities (Treasury bills and bonds) in the normal trading markets on a day-to-day basis.
In purchasing government securities the central bank creates money to hand it over to those selling. It issues currency notes (as in your wallet/purse) or it writes a cheque in the name of the owner. When the cheque is drawn on, the central bank just creates an amount of credit for itself to satisfy the buyer - money from thin air. When the central bank sells some of its stock of previously market-bought government securities, the purchasers draw on their money in the banking system, which leads to a lowering of reserves.To illustrate the creation of money by a central bank we can take Bank A's balance sheet from the example above. The starting position is:
Bank A: lending out just enough to attain minimum reserve ratio
| Assets | Liabilities |
| Reserves $21m Loans $84m | Deposits $105m |
The central bank wants to inject money into the financial system and lower interest rates. It offers to buy billions of dollars of government securities. One of the customers of Bank A sells $6 million of securities to the central bank. The central bank sends money to the customer of Bank A who deposits the newly created money (an electronic record rather than cash) in Bank A.[38] Bank A adds this $6 million to its reserve account at the central bank. Now Bank A's balance sheet looks like this:
Bank A balance sheet after an injection of $6 million
| Assets | Liabilities |
| Reserves $27m Loans $84m | Deposits $111m |
Bank A has a very high reserve level relative to its deposits, $27m ÷ $111m = 24.3%. The managers will want to employ the surplus money above that needed to maintain the target reserve ratio (20%) to earn higher interest by lending it.
If banks are more willing to lend to businesses and individuals because of the central bank intervention then interest rates are likely to fall, along with new money flows into the financial system. If the central bank wanted to raise interest rates by draining money from the system through open market operations it would sell government securities to investors, which reduces the amount held by banks in their reserve accounts at the central bank or reduces vault cash. This would curb lending and raise interest rates.Central banks tend to use Treasury securities to conduct open market operations because the secondary market in these securities is very liquid, there is a large volume of these securities held by dealers and investors, meaning that the market can absorb a large number of buy and sell transactions. The main method used is a repurchase agreement. The BoE generally uses repos with an average maturity of one or two weeks, but will also target long-term repos (3-12 months). The assets eligible for repo are gilts and sterling Treasury bills, UK-government foreign currency debt, eligible bank and local authority bills, and certain sterling bonds issued by supranational organisations and by governments in the European Economic Area. Turkey uses the repo market - see Article 16.1.