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There are no administrative barriers to the entry of new buyers and sellers, transactions are carried out without restrictions, the price is formed as a result of the free interaction of supply and demand.
Characteristics of an open market
The degree of market openness is determined by the following factors:- absence of legislative restrictions for entry (licensing requirements, obtaining patents, other administrative barriers);
- interaction large quantity participants: buyers and sellers. Each participant controls a small share of the market, and therefore is not able to significantly influence the price in the industry;
- offer of homogeneous, interchangeable goods;
- availability of information from buyers about sellers' prices. If one company unreasonably increases the price, the client may turn to another;
- establishment of tariffs and taxes that do not restrict freedom of trade.
Pricing on the open market
The interaction of open market participants influences the formation of the equilibrium price, which depends on two factors:- demand - the desire of buyers to purchase goods;
- proposals - the total volume and range of goods manufactured by manufacturing companies.
When deciding on production volumes, the company relies on three rules:
- Production costs should not exceed industry averages, otherwise financial results will be negative.
- Sales income must consistently exceed variable costs (i.e., expenses proportional to the volume of production - for wages of workers, purchase of raw materials, materials).
- The release of products makes sense if their price is higher than production costs.
If the price of a product on the open market exceeds the equilibrium price, supply is greater than demand. Some of the manufactured goods remain unclaimed, and a situation of overstocking arises. The profits of firms decrease, which forces them to reduce production volumes, the price falls, and the system returns to a state of balance.
If the cost of production is below the equilibrium value, demand increases and a shortage appears.
Indicators such as inflation, interest rates and exchange rates are used in open market transactions.
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✪ "Banking, Part 13: Open Market Operations"
✪ "Federal Reserve. Open Market Operations"
✪ "Open Market Operations and Analysis of Quantitative Easing"
Subtitles
Last time I mentioned that in this video we will discuss elasticity money supply. The money supply, which can change depending on the need for money. I took a little detour and told you about Treasury securities because they are very important point, and now, before we get started, let's remember what the money supply is. There are two definitions. First, when we looked at the concept of M0, I talked about gold reserves, but now we will expand this definition a little and look at the base money supply. Federal Reserve Deposits and Notes. So, in our fictional reality, all of the Federal Reserve's deposits were eventually converted into notes, but if this bank here didn't want to convert all the reserves into cash, it could keep some of them in a checking account at the Federal Reserve Bank. That is, Federal Reserve notes and Federal Reserve deposit accounts are essentially the same thing. Banknotes are just a little more fungible. You can give it to anyone, who in turn can give it to someone else, whereas with a checking or demand account at the Federal Reserve Bank, you have to make a wire transfer or write a check. But all this is the base money supply. You can call it the monetary base. Essentially, this is the size of the Federal Reserve's liabilities in a very broad sense. We'll take a closer look at the Federal Reserve's real balance sheet shortly. Now in our example the base money supply is 200 coins, now we'll call them dollars. Let's move away from gold coins. Let's just say that a dollar is equal to a gold coin for the purposes of our video. So our base money supply - I'll call it D0 - is now equal to 200. Here we have cash, the sum of which is made up of Federal Reserve notes and demand deposits. For example, there could be $100 here, in the form of a checking account at the Reserve Bank, and here, instead, there could also be a checking account. But it would still be considered part of the base money supply, because if this bank that has a checking account says it needs cash, then the Federal Reserve Bank will issue notes and close that checking account, which will turn back into notes. That is, they are equivalent. It's just a different way of keeping records. So here's the basic money supply. Now let's give a broader definition of the money supply. We can call it the money of bank turnover. A official name - D1. And this is the same concept that I looked at, I think, 10 videos ago. This means how much money people think they have. The amount of money in demand deposit accounts. In our case, this is it. All the depositors in this bank think they have $100, right? That $100 that they think they have and can write a check for. And there is also $100 in this bank. So the base money supply... No, that's not correct. No, no, please ask. It's not $100. Why did I say $100? Let's get a look. This bank has $100 in gold and can make loans up to $200, or can deposit up to $200 in demand deposit accounts. So he has $200. Because in the previous video we mentioned that the reserve ratio is 50%, and that tells us that if this bank has $100 in reserve, it can hold $200 in demand deposit accounts. We have repeated many times how this happens. This bank can do the same. He places $200 in demand deposit accounts. So the total amount of money that people think they have, for example, in deposit accounts... In our situation, I assume that all the cash is in the reserve bank, although we know that some of it will be in circulation . Let's just assume that we live in a world where everyone uses debit cards all the time and no one uses cash. I think we are moving towards this very quickly. As we will soon see, this increases the money supply. But, one way or another, I don’t want to delve into technical issues just yet. D1, which includes the total amount in demand deposit accounts in our world, is $400. And this connection is very important, since the regulatory reserve is 50%. So we can assume that banks are aiming to obtain an amount as close to their regulatory reserve as possible, since they do not receive interest on reserves. They receive interest on loans, which they issue depending on the opening of current accounts. If the nominal reserve were 10% and our base money supply was $200, we would probably see a D1 of $2000. So my question to you is... You might want to pause and think about this. How can a government, central bank, or economy increase or decrease the money supply? I suppose the first question that arises is why do this? Let's assume that we are already in this world and we only have two banks. And the money supply D1 is equal to $400. Let's say our economy is growing. We are able to produce more goods and services. Perhaps immigrants have come to us, there is more labor force. Or perhaps an innovative technology has appeared. Or maybe it's seasonal growth. Perhaps it is the planting season and many farmers need money to hire people. This is another time when you may need more money. If you don't increase the money supply in cases where your economy is growing or demand increases due to some seasonal fluctuations, if you don't increase the quantity of money, then it will become more expensive. I'll make a whole video dedicated to this. You should not be confused by the expression “money will become more expensive.” This means that in this case interest rates will increase. And if money gets too expensive, then some good projects will become impossible. This way you can limit economic growth. But we’ll talk separately about when it makes sense to expand or contract the money supply. Now let's look at how to do this in reality. There are two ways. If the regulatory reserve was 10%, then these banks could open more checking accounts, right? They could lend more money and open more checking accounts. If the regulatory reserve was 10%, then D1 would be equal to $2000, right? It would be ten times the size of this one, rather than two times the size of this one. And this is seen as one of the tools of the Federal Reserve Bank. Because, as we said earlier, the Federal Reserve Bank sets the size of regulatory reserves. But, if you think about it, the problem with this instrument is this... If we set the regulatory reserve at 10% and suddenly all these banks started lending large amounts money and they only have 10%, then what will happen? The ratio of reserves and current accounts will be 10%. Think about what would happen if you wanted to increase the regulatory reserve back to 50%. How could banks get 50% back? All banks would have to either start selling off assets or paying back loans. It would have been a very unpleasant situation. If you lowered the regulatory reserve and then wanted to raise it again, you would leave many banks starved of capital because most banks only work with what they need. Thus, you are unlikely to want to play with regulatory reserves. So the problem is that unless you change the regulatory reserve, which is the ratio of reserves to checking account funds, the only way to increase the number of checking accounts is to somehow increase the reserves. If you can somehow increase the actual reserves here. So my question is - how can you do this? Let's assume... You are, I hope, quite familiar with the fractional reserve banking system. And accordingly, you might notice that this also applies to the central bank. So, at the moment, all central bank deposits are backed by gold, 1:1. And there is nothing to prevent this bank from also doing fractional reserve lending. The central bank has no regulatory reserves. This is because it can always provide liquidity to some extent since the banknotes are guaranteed by the government. And the government can always collect more taxes to cover its borrowings. So the Federal Reserve can act as the printing press for the base money supply that people talk about. But there are two printing presses. The printing press for the monetary base and the printing press for leverage. If this increases... I'll make a whole video about it. I don't want to go too deep into technical details, I'm already running out of time. So what can the Federal Reserve do about this situation? It can print a certain number of banknotes. Let's say it prints 100 banknotes. He pays the Treasury to print banknotes for him, but he creates those banknotes himself and then, of course, guarantees their reliability, right? Issued and guaranteed notes, 100. And then he takes that $100. I mean these dollar bills , although it could be some kind of demand account or something... He takes these $100 bills that he printed, and then he can buy Treasury securities. So what would happen if the Federal Reserve took those $100 bills and bought Treasury securities? Treasury securities no longer have to be issued by the government. Because whenever a government issues securities, they are bought by many people all over the world. There is always some amount of Treasury securities held as long as the Treasury has some debt. So I have Treasury securities and let it be the central bank. I have several of these IOUs that I bought from the government. And the Federal Reserve has these $100. I'll paint it green. There are these $100. So the Federal Reserve buys these securities. I may not want to sell at the current price, so they will pay me a little more than the going price to get me to agree to part with my securities. And I'll do a whole video on what that means and how it changes the yield curve and so on. I just want to give you a basic understanding of the fact that the Treasury creates notes, issues them and offsets them... And then they can use those $100 bills to purchase Treasury securities or government bonds on the open market. What will happen now? Those $100 bills are now Treasury securities. I'll write: Treasury securities. And my question is that I had securities. They were lying under the mattress. And now I don't have these securities. But there is $100. What will I do with this $100? I'll put them in the bank. So I put my $100 in the bank. Maybe I'll put them here above and my checking account will go up a little, but what's the cumulative effect? Now the national banking system suddenly has more money, more dollar reserves, than can be applied to its reserve ratio. Now here is my contribution of $100. And now this bank can issue another loan in the amount of $100. So, in essence, I increased the monetary base, and now D0 has increased from $200 to $300 because I have $300 in notes issued. And now my D1 - I took this $100 bill that the Treasury gave me and put it in the bank account. Now I have a bank account with $100, and since the regulatory reserve is 50%, the bank can issue another loan. I know this already looks sloppy. $400... And now our D1 is $600. So, similarly, by printing money and issuing Treasury securities, the central bank is able to increase the D1 aggregate by $200. I will make more videos about this. I don't want to confuse you too much. See you! Subtitles by the Amara.org community
Process
Since most money today exists in electronic form rather than in the form of notes and coins, open market transactions are carried out by increasing ( lending) or decrease ( debiting) the volume of base money (monetary base) in a bank's reserve account with the central bank. Thus, the process does not require printing new currency. However, it increases the central bank's obligation to print money if a commercial bank requires notes in exchange for reducing the electronic balance.
When there is increased demand for base money, the central bank must take action if it wishes to keep short-term interest rates at target. It does this by increasing the supply of base money. The central bank goes to the open market to buy a financial asset (government bonds, foreign currency, or other relatively stable assets). To pay for an asset, the central bank creates new base money and credits the account of the bank selling the asset with it. This increases the monetary base in the economy. Conversely, if the central bank sells assets on the open market, a corresponding amount of base money is debited from the buying bank's account, thus reducing the base money.
Possible goals
Money is created and destroyed by changing a commercial bank's reserve account at the Federal Reserve. The Federal Reserve has conducted open market operations since the 1920s through the Open Market Division of the Federal Reserve Bank of New York under the authority of the Federal Open Market Committee. Open market operations are also a way to control inflation: selling government bonds to commercial banks reduces their ability to lend, thereby taking some money out of circulation.
The open market is the Central Bank's operations for the purchase and sale of government securities in the secondary market. Open market purchases are paid for by the Central Bank by increasing the seller's bank reserve account. Total cash reserves banking system increase, which, in turn, leads to an increase in the money supply. Sales of open market securities by the Central Bank will lead to the opposite effect: the total reserves of banks decrease and, other things being equal, the money supply decreases. Since the Central Bank is the largest open market dealer, an increase in the volume of purchase and sale transactions will lead to changes in the price and yield of securities. Therefore, the Central Bank can influence interest rates in this way. This is the best tool, but its effectiveness is reduced by the fact that the expectations of market participants are not entirely predictable. Advantages this method:The central bank can control the volume of transactions;
operations are quite accurate, bank reserves can be changed to any given value;
transactions are reversible, since any error can be corrected by a reverse transaction;
the market is liquid and the speed of transactions is high and does not depend on administrative delays.
In the open market, central banks use two main types of operations:
direct transactions - purchase and sale of securities with immediate delivery. Interest rates are set at auction. The buyer becomes the owner of securities that do not have a maturity date;
repo transactions are carried out on the terms of a repurchase agreement. Such transactions are convenient because the repayment terms can vary.
The types of open market operations are divided into:
dynamic operations - aimed at changing the level of bank reserves and the monetary base. They are permanent and involve direct transactions;
protective operations - carried out to adjust reserves in the event of their unexpected deviations from a given level, i.e., aimed at maintaining the stability of the financial system and bank reserves. For this type of transaction, repo transactions are used.
The use of open market operations depends on the level of development, the institutional environment and the degree of liquidity of the government securities market. As an analogue of open market operations, the Bank of Russia also uses foreign exchange interventions.
Foreign exchange interventions are the purchase and sale of foreign currency on the domestic market to increase or sterilize the money supply. They affect the exchange rate of the ruble against the dollar. The sale of dollars by the Central Bank will lead to an increase in the ruble exchange rate, the purchase - to its decrease. If the Central Bank conducts foreign exchange interventions to correct short-term exchange rate fluctuations, then it loses control over bank reserves and, accordingly, over the money supply. In addition to currency interventions, the Bank of Russia plans to use a more flexible instrument - currency swaps.
Currency swaps are transactions of purchase and sale of currency on the terms of immediate delivery with a simultaneous reverse forward transaction. They allow you to adjust the level of liquidity of the foreign exchange market without creating additional pressure on the ruble exchange rate.
What is bank refinancing?
Bank refinancing is a monetary policy instrument whereby the Central Bank grants a loan to a bank, that bank's account with the Central Bank is credited. The passive part of the Central Bank's balance sheet increases, and total reserves in the banking system increase. The assets of the Central Bank increase by the amount of the loan. As a result, an increase in refinancing volumes increases the volume of borrowed reserves in the banking system, the monetary base and money supply, while a reduction decreases it.
The central bank can influence the volume of refinancing in two ways:
influencing the value interest rate on loans;
influencing the amount of loans at a given interest rate using refinancing policies.
The refinancing policy affects the volume of bank lending through the mechanism for issuing loans and involves the Central Bank determining the goals, forms, conditions and terms of lending. Credit refinancing is also used as a stabilization tool
banking system. This is the most effective way to provide additional reserves and, accordingly, liquidity to banks during crisis periods.
Traditional form refinancing - recalculation of bills by the Central Bank, the meaning of which is that the Central Bank buys bills already discounted by banks.
The volume of refinancing depends on the level of the refinancing rate (the cost of loans from the Central Bank). But still, the refinancing rate is usually considered as an indicator of the intentions of the Central Bank. By changing the refinancing rate, the Central Bank announces its intentions regarding monetary policy.
Refinancing policy has less direct impact on monetary system. It is possible to directly determine the required change in borrowing reserves, but it is not known how much the refinancing rate needs to be changed in order for banks to apply for loans from the Central Bank. The costs for banks to use the refinancing rate are high and changing the refinancing rate turns out to be an ineffective tool due to the ambiguity of the impact on financial markets.
We are habitually outraged by rising prices and the depreciating ruble; we criticize the inaction or unsuccessful actions of the government.
But let’s admit, the general public is little familiar with the real levers of influence on the economic situation that the government has at its disposal.
Open market operations are the most important way, literally used weekly by the regulator, to control the money supply.
When there is an excess amount of money supply in circulation, it must be limited and eliminated. And then the Central Bank sells government securities to banks and other buyers. The desired effect of reducing the volume of money is achieved by reducing bank reserves.
Read more about this mechanism in the article.
Government monetary policy instruments
The main goal of the monetary policy of the government and the Central Bank is to achieve stabilization of national production, full employment, and moderate inflation through changes in the money supply. The volume of money supply in the country is controlled by regulating the size of excess reserves formed by commercial banks.
The specific methods by which the Central Bank influences excess reserves deserve separate consideration. First of all, let's name them:
- change in reserve norm;
- change in discount rate;
- open market operations.
Change in required reserve ratio
By changing the required reserve ratio, the Central Bank has a significant impact on the ability of banks to create new money through lending:
- An increase in the RR rate reduces the bank multiplier, excess reserves of the banking system and, consequently, the possibility of increasing the money supply. Such actions of the Central Bank qualify as restrictive (containing) monetary policy.
- If the Central Bank, on the contrary, reduces reserve requirements, then excess reserves of banks will increase. They will be able to provide loans in large sizes, and therefore the money supply will increase. This policy is called expansionist (stimulating).
Change RR - powerful weapon(largely due to the cumulative effect of the banking multiplier), and therefore it is resorted to extremely rarely. Instability of RR would mean unpredictability of credit resources, which is very undesirable for the money market.
Change in discount rate
The discount rate is the interest rate at which the Central Bank provides loans to commercial banks. They usually serve as a “last resort” for bankruptcy when other remedies have already been tried. When receiving a loan, a commercial bank issues its debt obligation, guaranteed by additional collateral: government short-term bonds and commercial bills.
- By lowering the discount rate, the Central Bank encourages commercial banks to turn to it for help, but does not allow them to abuse “cheap” loans.
- By raising the discount rate, the Central Bank seeks to reduce the interest of commercial banks in its loans and thereby limit the supply of money on the market.
Loans are issued only based on the results of an expert analysis, when the bank really needs help. By establishing control over the activities of a “needy” bank, the Central Bank seeks to understand the reasons for its difficulties. Often the issuance of such loans is accompanied by the appointment by the Central Bank of a new temporary administration of the bank.
Since the amounts of loans that the Central Bank can provide to commercial banks are relatively small, changes in the discount rate do not play a serious role in the formation of the money supply.
Open market operations
This is the most important, literally weekly used method of controlling the money supply. Open market operations refer to the purchase and sale by the Central Bank of government securities (bonds, bills) to commercial banks and the public. Government short-term securities are put into circulation by the Central Bank to cover that part of government spending that is not covered by taxes.
It is important to note that the initial placement of new bonds and bills at weekly auctions is not an open market operation. Only the secondary market for Treasuries is considered open.Let us consider how specifically the purchase and sale of government securities affects the excess reserves of commercial banks and, thereby, the supply of money. By purchasing treasury bonds from commercial banks, the Central Bank thereby increases their excess reserves (ER). The action of the bank multiplier gives a cumulative effect of growth in money supply: M3 = ER.
The same effect works in the opposite direction, when the Central Bank sells its government securities. That is, the reduction in the money supply turns out to be more significant than the reduction in excess reserves. The same final results are also obtained in the case when the Central Bank’s partner in transactions with government securities is the population and firms (OGSZ, OFZ, etc.).
The only difference is that by selling treasury securities to the Central Bank or buying them from it, individuals and firms change their current (settlement) accounts with commercial banks. Accounting for the Central Bank's obligations received from the population allows commercial banks, just as in the first case, to increase their excess reserves.
Open market operations quickly and efficiently affect the money supply. But what makes commercial banking firms and the public engage in these transactions with the Central Bank? It is not difficult to answer this question if you remember that the market value of securities and the actual percentage of income on them are inversely related.
When the Central Bank decides to buy government securities, it increases aggregate demand on them.
Their market value increases, the percentage of income decreases, and it becomes profitable for holders of securities to sell them. On the contrary, by selling treasury bonds, the Central Bank increases their supply on the market, thereby reducing their exchange rate value. But profitability increases. It will become profitable to buy securities.
In addition to the listed tools, there are a number of other methods of influence federal authorities for money offer:
- firstly, a margin may be established by law when purchasing securities. For example, when purchasing them, it is required to immediately pay at least 50% of the cost, and with your own and not borrowed funds. This measure is aimed against excessive speculation in securities that could cause a stock market crash and economic chaos;
- secondly, certain restrictions on consumer credit may be introduced.
Source: "de.ifmo.ru"
Open market operations are operations of the Central Bank for the purchase and sale of government securities
The open market is the operations of the Central Bank for the purchase and sale of government securities in the secondary market:
- Open market purchases are paid for by the Central Bank by increasing the seller's bank reserve account. The total monetary reserves of the banking system increase, which, in turn, leads to an increase in the money supply.
- Sales of open market securities by the Central Bank will lead to the opposite effect: the total reserves of banks decrease and, other things being equal, the money supply decreases.
Since the Central Bank is the largest open market dealer, an increase in the volume of purchase and sale transactions will lead to changes in the price and yield of securities. Therefore, the Central Bank can influence interest rates in this way. This is the best tool, but its effectiveness is reduced by the fact that the expectations of market participants are not entirely predictable.
Advantages of this method:
- The central bank can control the volume of transactions;
- operations are quite accurate, bank reserves can be changed to any given value;
- transactions are reversible, since any error can be corrected by a reverse transaction;
- the market is liquid and the speed of transactions is high and does not depend on administrative delays.
In the open market, central banks use two main types of operations:
- direct transactions - purchase and sale of securities with immediate delivery. Interest rates are set at auction. The buyer becomes the owner of securities that do not have a maturity date;
- repo transactions are carried out under the terms of a repurchase agreement. Such transactions are convenient because the repayment terms can vary.
By type, open market operations are divided into:
- dynamic operations - aimed at changing the level of bank reserves and the monetary base. They are permanent and involve direct transactions;
- protective operations - carried out to adjust reserves in the event of their unexpected deviations from a given level, i.e., aimed at maintaining the stability of the financial system and bank reserves. For this type of transaction, repo transactions are used.
The use of open market operations depends on the level of development, the institutional environment and the degree of liquidity of the government securities market.
As an analogue of open market operations, the Bank of Russia also uses foreign exchange interventions.
Foreign exchange interventions are the purchase and sale of foreign currency on the domestic market to increase or sterilize the money supply. They affect the exchange rate of the ruble against the dollar.The sale of dollars by the Central Bank will lead to an increase in the ruble exchange rate, the purchase - to its decrease.
If the Central Bank conducts foreign exchange interventions to correct short-term exchange rate fluctuations, then it loses control over bank reserves and, accordingly, over the money supply.
In addition to currency interventions, the Bank of Russia plans to use a more flexible instrument - currency swaps.
Currency swaps are transactions of purchase and sale of currency on the terms of immediate delivery with a simultaneous reverse forward transaction. They allow you to adjust the level of liquidity of the foreign exchange market without creating additional pressure on the ruble exchange rate.
Source: "aup.ru"
Indirect methods of monetary policy
Central bank operations on the open market are currently the main instrument in world economic practice within the framework of the applied indirect methods of monetary policy.
The Central Bank sells or buys highly liquid securities at a predetermined rate, including government securities that form the country’s internal debt, at its own expense on the open market. This instrument is considered the most flexible instrument for regulating credit investments and liquidity of commercial banks.
The peculiarity of open market operations is that the central bank can exert market influence on the amount of free resources available to commercial banks, which stimulates either a reduction or expansion of credit investments in the economy, while simultaneously influencing the liquidity of banks, reducing or increasing it accordingly.
This influence is carried out through changes by the central bank in the purchase price from commercial banks or the sale of securities to them on the open market.
The main securities with which transactions are carried out on the open market include the most liquid securities that are actively traded on the secondary market, the risk of which is extremely insignificant.
Such securities are various obligations issued by government authorities:
- debt certificates (Bank of the Netherlands, Bank of Spain, European Central Bank);
- financial bills (Bank of England, German Bundesbank, Bank of Japan);
- bonds (Bank of Korea, Central Bank of Chile, Bank of Russia).
The choice of securities depends on the degree of development of the financial market and the independence of the central bank, its ability to conduct transactions not only with government securities, but also with securities of other issuers.
The influence of the central bank on the money market and the capital market is that, by changing interest rates on the open market, the bank creates favorable conditions for credit institutions to buy or sell government securities to increase their liquidity.
Open market operations are usually carried out by the central bank in conjunction with a group of large banks and other financial institutions. Open market operations are more adapted to short-term market fluctuations compared to accounting policies.In the open market, central banks use two main types of transactions - direct transactions and repurchase agreements:
- Direct transactions mean the purchase and sale of securities for immediate delivery. The buyer becomes the unconditional owner of the securities. These types of transactions do not have a maturity date. Interest rates are set at auction.
- REPO transactions are carried out under the terms of a repurchase agreement. Direct repo transactions mean the purchase of securities by the central bank with the obligation of the dealer to buy them back after a certain period.
When concluding reverse repo transactions, or pairs (sometimes they are also called mismatch), the central bank sells securities and undertakes to buy them back from the dealer after a certain period. Such transactions are convenient because repayment periods can vary.
By type, open market operations are divided into dynamic and protective:
- Dynamic open market operations aim to change the level of bank reserves and the monetary base. They are permanent in nature and involve direct transactions.
- Protective operations are carried out to adjust reserves in the event of their unexpected deviations from a given level, i.e., they are aimed at maintaining the stability of the financial system and bank reserves. For this type of transaction, repo transactions are used.
The Bank of Russia used repo transactions widely from 1996 until the financial crisis of 1998. The subject of the transactions were government short-term bonds (GKOs) and federal loan bonds (OFZ).
The condition for concluding a direct repo transaction was the dealer's short position; for concluding a direct repo transaction, the dealer's short position was the result of trading within the limit established by the Bank of Russia. That is, transactions were concluded only when the dealer’s obligations exceeded the volume previously deposited in the trading system Money.
After the crisis, the Bank of Russia allowed inter-dealer repo transactions - the conclusion of repo transactions with GKOs - OFZs between dealers meeting certain criteria. It was assumed that this would allow the Bank of Russia to reduce the volume of money emission through a more rapid redistribution of bank reserves.
The use of open market operations as a monetary policy tool depends on the level of development, the institutional environment and the degree of liquidity of the government securities market. After the financial crisis of 1998, the Bank of Russia does not have such an opportunity.
Operations are hampered by the absence of government securities in demand in the portfolio of the Central Bank of the Russian Federation. Their resumption will depend on the adoption by the Government of the Russian Federation of a decision to re-register a sufficient part of the portfolio into securities with market characteristics.Today the Bank of Russia carries out transactions only with federal bonds. This is due to the fact that until recently the securities market of the constituent entities of the Russian Federation was not developed to the required extent. At the same time, the small volumes and low liquidity of these securities did not allow them to be used as a basic instrument for transactions.
The issue of using bonds of the constituent entities of the Federation in the future as the underlying asset for conducting operations on the open market has become increasingly discussed. It should be noted that the Bank of Russia’s decision to admit a particular asset or liability, or a particular issuer, for use in banking operations should not be related to a specific issuer or a specific asset.
Recently, individual corporate issuers have managed to obtain government guarantees for their obligations from some constituent entities of the Russian Federation. These issuers apply to the Central Bank of the Russian Federation with a request to include their assets in the list of securities for conducting operations by the Bank of Russia on the open market.
The inclusion of an asset of a corporate issuer in the list of securities accepted by the Bank of Russia as collateral actually initially gives a positive result. The issuer's securities are included in the Lombard List of the Central Bank of the Russian Federation - a list of securities that are accepted as collateral for repo transactions.
This may cause an increase in the attractiveness of such securities and an increase in trading activity with them. However, the Central Bank of the Russian Federation does not undertake any obligation to keep these securities on the Lombard List forever. At the slightest unfavorable change in the circumstances of the issuer's financial position, the Bank of Russia excludes such securities from the Lombard lists, which violates the stability of the securities market.
To avoid such a situation on the securities market, he decided not to include bonds of individual issuers in his transactions. In addition, it does not have the ability to monitor the financial position of each issuer to determine to what extent its bonds are appropriate to remain on the pawn list.
Specifics of Russian regulation stock market is such that the Central Bank of the Russian Federation can carry out operations on the stock market only in the government securities sector of the Moscow Interbank Center. Any other transactions with equity securities cause problems with obtaining a license as a professional participant in the stock market.
To maintain liquidity in the government securities market, the Bank of Russia uses “repo operations.”
The Bank of Russia may provide funds to a primary dealer in the securities market to close a short open position (i.e. when liabilities are greater than claims) in exchange for government securities. The dealer undertakes to repurchase the same securities after a certain period of time, but at a different price. The term of the repo transaction is fixed and is 2 days.
The repo market is a fairly effective short-term instrument of the Bank of Russia’s monetary policy and one of the indirect instruments for maintaining liquidity in the government securities market.
Source: "eclib.net"
Open Market Operations
Open Market Operations are deposit and credit repo operations, transactions for the purchase and sale of assets (securities or currency).
Open market operations are conducted primarily using government securities.
Open market operations are monetary operations and, in countries with an active interest rate policy, constitute the operating basis for the monetary policy of the country's central bank.
Their use, along with the mechanism of mandatory reserve requirements and standing deposit and overnight credit operations, makes it possible to effectively regulate the monetary market and implement monetary policy.Open market operations are divided into the following types:
- regular;
- operations for refinancing or depositing for more long term(usually 3 months, less often - 6, 9, 12 months);
- adjustment operations;
- structural operations.
Regular open market operations are the most common operations of central banks. They are carried out regularly on a clearly defined schedule. Most often these are deposit or credit transactions on the open market with 7 or 14 day terms.
Regular open market operations are the operational basis of the monetary policy of central banks and are used to regulate interest rates, manage market liquidity and reflect the state of monetary policy.
Regular open market operations provide the bulk of bank refinancing in conditions of insufficient liquidity or sterilization of banks' liquidity in conditions of its excess level. The interest rate for regular operations on the open market is recognized as the base rate of the central bank and is a reference point for the cost of money for monetary market entities.
Refinancing or deposit operations for a longer period (usually 3 months, less often - 6, 9, 12 months) are carried out at market rates according to the standard tender procedure on a repayable basis with monthly regularity.
Adjustment operations are intended to quickly correct unexpected fluctuations in market liquidity in order to smooth out the impact on interest rates.
They do not have standardized terms and regularity and are carried out mainly in the form of reverse transactions, less often they can take the form of direct transactions, foreign currency exchange swaps and attracting time deposits through quick tenders or bilateral procedures.
Structural operations are carried out at the initiative of the central bank for the structural regulation of the financial market through the issuance of debt certificates, reverse and forward operations on a regular or irregular basis.
Source: "discovered.com.ua"
What are open market operations
Open market operations are a kind of transactions carried out exclusively at the official level by the central bank of a particular country.
Open market operations ("OMO") consist of any purchase and sale of government securities, and sometimes commercial securities, by a central bank authority for the purpose of adjusting the money supply and credit conditions on an ongoing basis.
Open market operations can also be used to stabilize prices of government securities, a goal that conflicts with the central bank's temporary lending policy.
When the central bank buys securities on the open market, the effect will be to increase the reserves of commercial banks, from which they can expand their lending and investment.
To increase the value of government securities, which is equivalent to reducing interest rates and to reduce interest rates, usually thereby encouraging investment in business. Open market operations typically involve short-term government securities (in the United States, often Treasury bills).
Observers disagree about the wisdom of such a policy. Proponents believe that dealing with both short-term and long-term securities will distort the interest rate structure and hence the allocation of credit.
Opponents believe that this would be entirely appropriate since interest rates on long-term securities have a more direct impact on long-term trends investment activities, which is responsible for fluctuations in employment and income.
Federal Reserve System
Open market operations are the Federal Reserve System's (Fed) most flexible and frequently used means for implementing a government's monetary policy.
The Federal Reserve has several various types OMOs, although the most commonly used are repos and securities purchases. Open market operations allow the Fed to influence the supply of reserve balances in the banking system and thereby influence short-term interest rates and the achievement of other monetary policy objectives.
In addition to open market operations, the Fed can influence the level of reserve balances by either reinvesting proceeds from maturing securities in the open market account into new securities (reserve and neutral) or redeeming them with maturing securities (reserve drainage).
Open market operations are one of the three main tools used by the Federal Reserve to achieve its monetary policy objectives.
Other instruments change the conditions for borrowing discounts and adjust required reserve ratios. Executing an OMO in the “open market,” also known as the secondary securities market, is the purchase of the Federal Reserve's most flexible means to carry out its purposes.
By adjusting the level of reserve balances in the banking system through open market operations, the Fed can offset or maintain persistent, seasonal, or cyclical changes in the supply of reserve balances and thereby affect short-term interest rates and the expansion of other interest rates.
Efficiency of use of reserve balances
The Federal Open Market Committee is the highest monetary policy authority of the Federal Reserve System. It delegates responsibility for the implementation of US monetary policy to the Market System open account manager at the Federal Reserve Bank of New York through authorizations.
This permission is contained in the minutes of the first meeting of each year. The manager is responsible for employees at the Federal Reserve Bank of New York. Thus, the bureau performs open market operations on behalf of the entire Federal Reserve System.After each policymaker's meeting, which occurs every six to eight weeks, the FOMC issues a SOMA Manager Directive, which sets out the approach to monetary policy that the FOMC considers appropriate for the specified period of time between its meetings. The Directive contains the rate at which the FOMC would like to receive funds for trading for a certain period.
The Federal Reserve conducts open market operations with primary dealers, dealers in government securities that have an established trading relationship with the Federal Reserve.
Thus, while the policy target rate is the unsecured lending rate between banks (the Fed Funds), and the Federal Reserve operates in the collateralized lending market with primary dealers (repos). This structure works because primary dealers have accounts with clearing banks, which are depository institutions.
Therefore, when the Federal Reserve sends and receives funds from a dealer's account to its clearing bank, the action adds or drains reserves into the banking system.
Because of this adjustment to the supply of reserve balances, open market operations affect federal funds and the interest rate that depository institutions pay when they borrow unsecured reserve balances over time from each other.
Banks may borrow reserves from the federal funds market to meet reserve requirements set by the Federal Reserve and to maintain adequate balances in their Fed accounts to cover checks and electronic payments on their behalf.
Changes in the federal funds rate often have a strong impact on other short-term rates. In order to most effectively influence the level of reserve balances, the Federal Reserve has created what is called a "structural deficit."
That is, it has created constant additions to the supply of reserve balances, which are somewhat less than the volume of the total demand. Then on a seasonal and daily basis, everything is positioned to add balances temporarily to get to the right level.Specifically, the bureau creates a “SOMA” portfolio by purchasing U.S. Treasury securities on the open market. Because the COMA buy-and-receive portfolio, the securities purchased in it are typically held until maturity and are included in the Fed's securities purchases in ever-increasing levels of reserve balances.
In addition to the COMA portfolio, the Fed's overall portfolio includes long-term repo books and a short-term repo book. Repos are also called repurchase agreements or RPS, which is a form of collateralized lending where the Fed lends money to the primary dealers and the primary dealers give high-quality securities to the Fed as general collateral for the loan.
REPO transactions
While the COMA portfolio offsets factors that continually drain or remain from the banking system in the form of Federal Reserve notes, repo accounting is used over the long term to offset seasonal movements in factors. Long-term repos currently have a maturity of 14 days and are conducted every Thursday early in the morning.
The repo book is short-term, consisting of repo transactions with shorter than 14-day maturities, and a predominance of overnight repo transactions. These transactions are typically carried out every day to fine-tune the level of bank reserves needed that day.
Although typically these transactions will add balances, sometimes the system must have outstanding balances, in which case the bureau will conduct a reverse repo transaction.
Reverse repo transactions are the opposite of RP. Instead of the loan money going to the dealers, the desk borrows money from the dealers against the collateral from the system's open market account. Repos and reverse repos can be conducted for a period of up to 65 business days. They are usually settled on the same day, although they can be resolved earlier.
For information on eligible repos to be secured, the Federal Reserve Act and the internal authorization that exists in the minutes for the first annual meeting should be reviewed.
Collection of information, preparation and conduct
Staff begins each workday by collecting information about market activity from a range of sources. Fed traders discuss with primary dealers how events in the securities market may unfold the next day and how the dealers' task of financing their securities positions is progressing at that time.
The staff also speaks with large banks about their reserve needs and the plans of banks to meet them and about the work of brokers, as well as their activities in this market. Collecting data on bank reserves for the previous day and forecasting factors that may affect reserves for future days is a task for operational staff.
The staff also receives information from the Treasury about its balance sheet at the Federal Reserve and also assists in Treasury management. this balance and treasury accounts in commercial banks. Following discussions with the Treasury, stock forecasts have been completed.Then, after reviewing all the information collected from various sources, the bureau staff needs to develop a plan of action for the day. This plan is reviewed with stakeholders around the system during a conference call each morning. Conditions in the financial markets, including domestic securities and money markets, as well as foreign exchange markets, are currently being reviewed.
When the conference call is completed, the table conducts any agreed upon open market transactions. The Bureau initiates this process by declaring the OMO through electronic system auction called FedTrade, a decision for dealers to submit bids or offers, as appropriate. For a repo transaction, the announcement states the time and duration of the auction, but does not determine its size.
The size of the operation is usually announced later, after the operation is completed. Dealer proposals are evaluated based on competitive best price. Primary dealers typically allow about 10 minutes to submit their bids and notification of results about a minute after the auction closes.
The auction results will also be simultaneously sent to the bank's external website. Auctions for direct purchases typically become known later in the morning.
The announcement contains a range of maturities for Fed securities, consideration for purchase opportunities, and a list of all securities that will be excluded within that range. These operations are typically open for about 30 minutes.
Dealers bid on the securities, and the Federal Reserve compares the relative advantage of bids across the securities, accepting the best relative bids submitted by the participating parties.
Typically, earnings are reinvested, as is the size of the permanent reserve. From time to time, due to portfolio recommendations or reserve requirements, earnings will be generated, which reduces the portfolio size and completely depletes reserve balances from the banking system.
Source: "biznes-prost.ru"
Open Market Operations of the Central Bank
By buying or selling government securities on the open market, the Central Bank can either inject resources into the state's credit system or withdraw them from there.
Open market operations are usually carried out by the Central Bank together with a group of large banks and other financial institutions. Operations for the purchase/sale of securities on the open market are used in the practice of most central banks.
These operations can:
- be one of the main instruments for regulating bank liquidity on a daily basis (for example, in the USA, Canada and Australia),
- or used as an anti-crisis tool to carry out additional injections of funds into the banking sector and/or influence longer-term yields in the segment of government and corporate bonds (in particular, the Bank of England, the Bank of Japan, the US Federal Reserve).
In the practice of the Bank of Russia, transactions for the purchase/sale of securities on the open market are used on a relatively small scale as an additional tool for regulating bank liquidity. The main factor reducing the potential for its use of this instrument is the relative narrowness and low liquidity Russian market government securities.
In addition, during the period of formation of a banking liquidity surplus, the use of this instrument is limited by the relatively small size of the Bank of Russia’s own securities portfolio.According to the legislation, the Bank of Russia can purchase/sell both government and corporate debt securities on the market (shares only within the framework of repo transactions). At the same time, the purchase of government securities by the Bank of Russia can only be carried out on the secondary market (in order to limit the possibilities of direct emission financing of the budget).
In the practice of the Bank of Russia, the purchase/sale of corporate securities was used only as part of repo transactions, or when selling securities received as collateral under repo transactions in the event of improper fulfillment by counterparties of their obligations under the second part of the transaction.
Direct transactions for the purchase/sale of government securities without obligations to resell/repurchase are used irregularly by the Bank of Russia.
- Let us assume that there is a surplus of money supply in circulation in the money market and the Central Bank sets the task of limiting or eliminating this surplus.
- Let us now assume that there is a shortage of funds in circulation in the money market. In this case, the Central Bank pursues a policy aimed at expanding the money supply
In this case, the Central Bank begins to actively offer government securities on the open market to banks and other business entities that buy government securities through special dealers. As the supply of government securities increases, they market price falls, and interest rates on them rise, and, accordingly, their “attractiveness” for buyers increases.
The population (through dealers) and banks begin to actively buy government securities, which leads to a reduction in bank reserves.
A reduction in bank reserves, in turn, reduces the money supply by a proportion equal to the bank multiplier.
Namely: the Central Bank begins to buy government securities from banks and the population. Thus, the Central Bank increases the demand for government securities. As a result, their market price rises and their interest rate falls, making Treasury securities “unattractive” to their holders.
The population and banks begin to actively sell government securities, which leads to an increase in bank reserves and (taking into account the multiplier effect) to an increase in the money supply.
A repo operation is a transaction consisting of two parts: the sale and subsequent purchase of securities after a certain period at a predetermined price. The difference between the sale and purchase prices is the cost of borrowing through a repo transaction.The mechanism of repo transactions implies that for the period of provision of funds, the securities acting as collateral become the property of the lender, which reduces the credit risk for this type of transaction and simplifies the resolution of situations in the event of default by the borrower.
Currently, REPO operations are used by the Bank of Russia only to provide liquidity to commercial banks:
- In the first part of the transactions, the Bank of Russia acts as a buyer, and its counterparty - a credit institution - as a seller of securities accepted as collateral.
- In the second part of the transactions, the Bank of Russia resells the securities of the credit institution at the price established at the time of the transaction.
REPO operations with the Bank of Russia are carried out at organized auctions on stock exchange MICEX and the St. Petersburg Currency Exchange, as well as not in organized trading using information system Moscow Exchange and Bloomberg information system.
Reverse modified repo operations, which provide for the sale by the Bank of Russia of securities from an established list with an obligation to repurchase, were used by the Bank of Russia as a tool for absorbing bank liquidity until 2004 and are not currently carried out.
Example. At the beginning of 2014, the ruble exchange rate began to fall rapidly. Due to growing inflationary fears, this situation no longer suited the Bank of Russia.
The monetary regulator stopped one-day repo operations with banks that previously used the proceeds for speculation in the foreign exchange market, and also reduced offers on seven-day repo operations conducted on Tuesdays. As a result, commercial banks began to take profits on foreign exchange positions to fill liquidity gaps, and the ruble began to strengthen.
Operations with Bank of Russia bonds
The issuance by central banks of their own short-term bonds is quite widespread in the world practice of conducting monetary policy. These operations are used especially actively in countries with developing financial markets, which are characterized by a systematic surplus of liquidity in the banking sector.
Central banks, in particular, issue their own bonds South Korea, Israel, Brazil, Chile, Republic of South Africa. The placement of central bank bonds is used to sterilize liquidity, usually for periods from several months to 1 year, but it is also possible to use longer-term securities (with terms up to 3-5 years).
Operations with central bank bonds are a fairly flexible tool for regulating bank liquidity, since the credit institution that holds them can, if necessary, use them as collateral for interbank lending operations and/or attracting refinancing from the central bank.
In addition, the credit institution can also sell these securities on the secondary market, or, if so provided, sell them to the central bank. The Bank of Russia issues its own bonds (Bank of Russia bonds - OBR) on a regular basis in order to regulate the liquidity of the banking sector.
During periods of formation of a stable surplus of banking liquidity, operations with OBR are one of the market instruments for sterilizing liquidity (this type of operation also includes deposit auctions).The convenience of using OBR transactions for credit institutions is the possibility of early sale of securities on the secondary market, as well as the possibility of using them as collateral both for interbank lending transactions and for Bank of Russia liquidity provision operations.
OBRs are included in the Lombard List of the Bank of Russia and are accepted as collateral for Bank of Russia loans secured by collateral (blocking) of securities and direct repo operations of the Bank of Russia.
OBRs are issued in the form of zero-coupon discount bonds, which provides for the sale of bonds to holders at a price less than par value, with subsequent redemption of bonds at par value in the absence of coupon payments to holders during the circulation period of the issue.
The right for the Bank of Russia to issue its own bonds for the purpose of implementing monetary policy is established by Art. 44 Federal Law dated July 10, 2002 No. 86-FZ “On the Central Bank of the Russian Federation (Bank of Russia)”. The issue of OBR is carried out in accordance with Art. 27.5-1 of the Federal Law of April 22, 1996 No. 39-FZ “On the Securities Market” and Bank of Russia Regulations of March 29, 2006 No. 284-P “On the procedure for issuing Bank of Russia bonds.”
A tool for flexible and prompt influence on the volume of liquid resources of commercial banks is open market operations. Open market operations refer to the buying and selling of government securities to change the money supply. By regulating the supply and demand for government securities, the effect of fluctuations in the volume of money supply in circulation, caused by the nature of the response actions of commercial banks, is achieved. Yes, sale commercial bank government chain securities narrows the available resources of commercial banks for lending purposes, and the purchase, on the contrary, frees up resources and increases lending opportunities.
Conducting operations on the open market, known as open-market policy, began to be used since the 20s. XX century in the USA. The German bank carried them out since 1933, Great Britain - also in the 30s. Open market policies quickly gained popularity due to their high efficiency and flexibility, displacing other methods of monetary regulation.
Reducing the lending capabilities of commercial banks is advisable during periods of high market conditions, increasing them during times of crisis. In a crisis situation, the central bank creates the possibility of refinancing for commercial banks. It puts them in a situation where selling securities to the central bank becomes profitable. There is a simultaneous change in the lending interest and liquidity of commercial banks. At the same time, purchasing securities from the Central Bank is advisable when there is low demand for commercial bank loans from firms and households. At the same time, the conditions of the central bank for the purchase of securities should be more favorable than the conditions for providing loans to the population and enterprises of the non-financial sector.
The success of the open market policy is facilitated by the development of financial market institutions in the West. Here, central banks operate alongside other lending institutions, including savings and investment companies and businesses. A strong liquidity reserve of commercial banks confirms its financial activity and can be ensured as high
Chapter 8. Monetary regulation
both profits and a large portfolio of high-yield securities.
There may be some differences in conducting open market transactions. Traditionally, the Bank of Germany sets the interest rates at which it is willing to buy securities. However, sales volume is not subject to regulation. On the contrary, in the USA and England, the Central Banks determine the volumes of purchase and sale, in accordance with which commercial banks will purchase securities from them. The interest rate here is determined indirectly and depends on the period for which government securities are placed.
The operation of purchasing securities on the terms of a reverse transaction has also found application in the implementation of open market policies. In this case, the Central Bank purchases securities from commercial banks for a period, after which commercial banks repurchase the sold securities at a discount, i.e. at a discount relative to the price of the original transaction. REGU transactions are carried out, which are also used in the relationships of commercial banks with clients. Here, overnight or term repurchase agreements involve the sale of highly liquid securities to banks (in the US - Treasury or federal agency) on the terms of their redemption on another day (overnight) or for a longer period (from a week to a month) at a higher price. The premium to the value of the initial transaction constitutes the income of the commercial bank that provided credit to the client on the security of the transferred securities.
Carrying out an effective open market policy in the Russian Federation requires expanding the capacity of the financial market and adequate functioning of its mechanisms.
In the West in different time The main instruments for implementing the open market policy were:
Treasury bills;
Government and local government debt obligations;
Interest-free treasury certificates;
Debt obligations admitted to exchange trading;
Special bills.
According to experts, after August 1998 the Bank of Russia was faced with the task of developing a mechanism for restoring financial
Part III. Banking intermediation: institutions and organization
of the new market, since open market operations are an important tool for regulating the liquidity of the banking system. Under these conditions, the Central Bank offered the market its own short-term zero-coupon bonds of Russia - OBR. These bonds are short-term in nature: circulation period is up to 3 months, maximum issue volume is 10 billion rubles. The Central Bank has provided commercial banks with the opportunity to use them as collateral for pawnshop, intraday and overnight loans.
At the stage of recovery of the financial market, the importance of the regulatory activities of the Central Bank of the Russian Federation increases. The government securities market should acquire a new qualitative level, expressed in the predictability of its dynamics and a reduction in the share of speculative transactions carried out. Securities that require a differentiated approach will be traded on it, for example:
Securities issued for the restructuring of GKO-OFZ;
New public debt instruments.
The circulation of municipal securities will continue, the prospects of which will largely be determined by the state of the regional economy and finances.
The position of the market for foreign currency government securities (Eurobonds, domestic foreign currency loan bonds, etc.) will only improve with an increase in Russia's credit rating. Assuming the gay to activate the sector of corporate debt obligations - mortgage-backed bonds, commercial bills, etc., which will allow for the transfer of capital from government securities into the corporate segment.
Cm." Fundamentals of banking (Banking) / Ed. K. R. Tagirbekova M.: INFRA-M; Publishing house "The Whole World", 2001. P. 92..
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