Explain open market operations.

1. Open market operation refers to the purchase and sale of securities by RBI in the open market to the commercial banks or the general public.

2. It is done to increase or decrease the stock of money supply in the economy.

3. It is a method of credit control by the central bank.

4. It is a quantitative instrument of the money supply.

5. If the central bank purchases securities, it affects the money kept with the public, by indirectly affecting their deposit and withdraw ability in the commercial bank. Thus, credit creation is affected.

6. If the central bank sells securities, it will withdraw the cash balance from the economy.

7. For example, the central bank purchases securities worth Rs 5000 from a bondholder issuing a cheque. The seller of this security will show this cheque in the commercial bank.

8. The bank will credit the account with Rs5000 and the bank’s deposit will increase by the same amount.

9. This is a liability to the bank as it has to pay back the amount and credit is created.

10. So, the purchase of security increases the credit creation and the selling of securities reduces it.