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Banking Book

Banking Book

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Publicado por9290010274
Banking Book
Banking Book

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Published by: 9290010274 on Nov 08, 2011
Direitos Autorais:Attribution Non-commercial

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08/03/2013

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The theory underlying the operation of open market operations is that by the purchase
and sale of securities, the central bank is in a position to increase or decrease the cash
reserves of the commercial banks and therefore increase or decrease the supply of credit in
the economy.

Central Banking

37

The modus operandi of open market operations can now be explained. During a period
of inflation, the central bank seeks to reduce the supply of credit in the economy. Hence,
it sells the securities to the banks, public and others. As a result of the sale of securities by
the central bank, there will be a transfer of cash from the buyers to the central bank. This
will reduce the cash reserves of the commercial banks. The public has to withdraw money
from their accounts in the banks to pay for the securities purchased from the central bank.
And the commercial banks themselves will have to transfer some amount to the central
bank for having purchased the securities. All this shrinks the volume of cash in the vaults
of the banks. As a result the banks will be unable to expand the supply of credit. When the
supply of credit is reduced by the banking system, the consequences on the economy will be
obvious. Investment activity is discouraged ultimately leading to a fall in the price level.

On the other hand, during a period of deflation, in order to inject more and more credit
in to the economy, the central bank purchases the securities. This will have an encouraging
effect on investment because the banks supply more credit following an increase in their
cash reserves. Thus, the central bank seeks to combat deflation in the economy.

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