In macroeconomics, an open market operation (OMO) is a monetary tool used by the central bank case in point Reserve Bank of Zimbabwe (RBZ) to expand or contract liquidity.
The central bank can either buy or sell government bonds (or other financial assets) in the open market. Central banks usually use OMOs as the primary means of implementing monetary policy.
The usual aim of open market operations apart from supplying commercial banks with liquidity and sometimes taking surplus liquidity from commercial banks is to manipulate the short-term interest rate and the supply of base money in an economy, and thus indirectly administering the aggregate money supply.
By using OMOs, the Reserve Bank of Zimbabwe can influence short-term rates, long-term rates, and foreign exchange rates.
This can change the amount of money and credit available in the economy and affect certain economic factors, such as unemployment, output, and the costs of goods and services.
Below I will discuss the ways through which central banks can use OMO.
Purchasing Government bonds from banks
When the country’s central bank buys government bonds, it stands to reason that the economy is usually in the recessionary gap phase with massive unemployment challenges.
By purchasing government bonds, the central bank increases the money supply in the economy.
The increased money supply decreases interest rates which in turn boost consumption and investment spending.
The ultimate effect causes aggregate demand to rise and an increase in the Gross Domestic Product.(GDP).In essence, buying government bonds from banks increases the real GDP of the economy which makes this method an expansionary monetary policy.
Selling Government bonds to banks
The central bank could also sell government bonds to banks when the economy faces inflation. When the central bank sells government bonds, it mops the excess liquidity from the economy.
This causes a drop in the money supply which in turn forces interest rates to rise.
An increased interest rate causes consumption and investment spending to fall, and thus aggregate demand falls.
Selling government bonds to banks decreases the real GDP of the economy and is referred to as a contractionary monetary policy tool.
Pros and cons of open market operations
Open market operations gives the central bank the ability to influence interest rates without actually being able to tell banks what to charge for a loan.
By injecting money into the economy or taking money out of it, the central bank can influence rates one way or the other.
These actions by the central bank are not only beneficial to the economy but can also benefit individuals as well.
If one is planning to buy a house just about the same time an OMO is enforced, a reduction in interest rates may mean a better house purchase.
One of the downsides of open market operations is that they are a constant balancing act.
The Reserve bank of Zimbabwe has the mandate to ensure that both inflation and employment are maintained at levels that are not precarious.
If the economy garners growth pace at an increasing rate, the RBZ may use its powers to increase interest rates. Albeit when money becomes more expensive, the economy feels it. A slowdown can eventually lead to a reduction in employment.
Blessing Nyatanga holds a Bachelor’s degree in Banking and Investment Management fromNUST.0784909184/[email protected]