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Open Market Operation (OMO)

Learning Objective:

The objective of this question is to enable the students in understanding the process of Open Market Operations (OMO) and its impact on overall economy of a country.

Discussion Question:

Open Market Operation (OMO) is an effective monetary policy tool in the hands of central bank of a country in which the central bank buys or sells securities in financial markets for controlling money supply and financial stability of a country. Suppose there is a danger that the banks of the country will face liquidity problem during EID holidays owing to excessive cash withdrawal demands by the people. Can central bank of a country solve this problem through Open Market Operation (OMO)? If ‘YES’ then how? If ‘NO’ then why? Elaborate your answer with strong logical arguments by explaining the complete procedure of Open Market Operations.

Important Instructions:

Your discussion must be based on logical facts.
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Open Market Operation (OMO) is an effective monetary policy tool in the hands of central bank of a country in which the central bank buys or sells securities in financial markets for controlling money supply and financial stability of a country. Suppose there is a danger that the banks of the country will face liquidity problem during EID holidays owing to excessive cash withdrawal demands by the people. Can central bank of a country solve this problem through Open Market Operation (OMO)? If ‘YES’ then how? If ‘NO’ then why?
Elaborate your answer with strong logical arguments by explaining the complete procedure of Open Market Operations. Solution: In my opinion Yes thorough through Open Market Operation (OMO) central bank solve this problem.
Using OMOs the central bank either provides funds to the market by lending against collateral or mops-up the surplus liquidity
. To inject liquidity, the SBP purchases treasury bills from the commercial banks generally with an agreement of sale—or reverse repo
. However, it has been almost two weeks since Eid holidays ended and the banks are still facing liquidity problems.
Interesting banks are looking towards central bank’s short-term lending facility to meet their liquidity obligations but they also heavily park their money into the riskfree government securities, they added.
Open Market Operations refer to the purchase and sale of the Government securities to market. The objective of Open Market Operations is to adjust the rupee liquidity conditions in the economy on a durable basis.
When Central Bank sells government security in the markets, the banks purchase them. When the banks purchase Government securities, they have a reduced ability to lend to the industrial houses or other commercial sectors. This reduced surplus cash, contracts the rupee liquidity and consequently credit creation / credit supply. When Central Bank purchases the securities, the commercial banks find them with more surplus cash and this would create more credit in the system. Thus, in the case of excess liquidity, Central resorts to sale of government security to suck out rupee from system. Similarly, when there is a liquidity crunch in the economy, Central buys securities from the market, thereby releasing liquidity. It’s worth note here that the market for government securities is not well developed in Pakistan but still OMO plays very important role

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solution:-

Yes, the central bank can lend the money to country’s commercial banks by buying back the securities initially sell; to counter liquidity issues in the market up to the level that central banks reserves must be backed by gold.

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