Open Market Operations
In open market operations, the Federal Reserve buys and sells U.S. Treasuries and federal agency securities in the secondary market. This is the most common tool of the Fed and you should understand it fully for the exam. To stimulate the economy, the Fed will purchase government securities. The money it spends to purchase the securities releases more money into the money supply. More money in the economy brings interest rates down. Lower interest rates allow consumers to borrow more and then spend more, growing the economy.
If the Fed wants to slow the economy because inflation is on the rise, it will sell Treasury securities. When the Fed sells Treasuries, money is delivered to the Fed, which removes it from the economy. The reduced money supply causes an increase in the cost of credit. When borrowing is more expensive, Americans borrow less and spend less, slowing inflation and the broader economy.
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