An rate falls. However, Open Market Operation

An Open Market Operation (OMO) is the selling and buying of government inthe open market in order to expand the amount of money in the banking system.Securities’ purchases inject money into the banking system and stimulategrowth, while sales of securities do the opposite and contract the economy. TheFederal Reserve enables this process and therefore uses this technique toadjust and manipulate the federal funds rate, which is the rate at which banksborrow reserves from one another. The first tool that the Federal Reserve tendsto use is the manipulation of short-term interest rates.

This practise involvesvariations of raising and lowering interest rates to help spur the economicactivity whilst also trying to maintain inflammation. Mechanics are quitesimple; by lowering interest rates money becomes cheaper to borrow and lessprofitable, influencing individuals and other corporations to spend. Therefore,as interest rates are lowered, savings start declining; leading to more moneybeing borrowed and more money is being spent. As more money is being borrowed,the total supply of money in the economy increases. The implications of thisend result of decreasing the interest rates are less lucrative, more moneysupply, increased spending, and higher overall economic activity.

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 Open Market Operation purchase process and impacts involves when RBApurchase securities from banks and then pays the bank with newly created bankreserves and money. With more reserves in the banking system the supply of interbankloans and money increases, and the cash rate falls. However, Open MarketOperation sale process and impacts involves when RBA sell securities to banks,hence bank pays. With fewer reserves in the banking system, the supply ofinter-bank loans and money decreases, and the cash rate rises. However, lowered interest rates also have a habit of increasinginflation.

This negatively effects the GDP because the total supply of goodsand services is limited in short run and with more money chasing that finiteset of GDP, prices go up.


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