How does the Fed carry out open market operations? At the end of each meeting, the FOMC issues a statement that includes its target for the federal funds rate and its assessment of the economy, particularly with respect to its policy goals of price stability and economic growth.
In addition, the FOMC issues a policy directive to the Federal Reserve System’s account manager, who is a vice president of the Federal Reserve Bank of New York and who has the responsibility of implementing open market operations and hitting the FOMC’s target for the federal funds rate.
Open market operations are conducted each morning on the Open Market Trading Desk at the Federal Reserve Bank of New York. The trading desk is linked electronically through a system called the Trading Room Automated Processing System (TRAPS) to about 18 primary dealers, who are private securities firms that the Fed has selected to participate in open market operations.
Each morning, the trading desk notifies the primary dealers of the size of the open market purchase or sale being conducted and asks them to submit offers to buy or sell Treasury securities. The dealers have just a few minutes to respond.
Once the dealers’ offers have been received, the Fed’s account manager goes over the list, accepts the best offers, and then has the trading desk buy or sell the securities until the volume of reserves reaches the Fed’s desired goal. These securities are either added to or subtracted from the portfolios of the various Federal Reserve banks according to their shares of total assets in the system.
How does the account manager know what to do? The manager interprets the FOMC’s most recent policy directive, holds daily conferences with two members of the FOMC, and personally analyzes financial market conditions. Then the manager compares the level of reserves in the banking system with the level the trading desk staff estimates will be necessary to hit (or maintain) the target federal funds rate.
If the level of reserves needs to be increased over the current level, the account manager orders the trading desk to purchase securities. If the level of reserves needs to be decreased, the account manager orders the trading desk to sell securities. In conducting the Fed’s open market operations, the trading desk makes both dynamic, or permanent, open market operations and defensive, or temporary, open market operations.
Dynamic open market operations are intended to change monetary policy as directed by the FOMC. Defensive open market operations are intended to offset temporary fluctuations in the demand or supply for reserves, not to carry out changes in monetary policy.Dynamic open market operations are likely to be conducted as outright purchases and sales of Treasury securities—that is, by buying from or selling to primary dealers.
Defensive open market operations are much more common than dynamic operations. Defensive open market purchases are conducted through repurchase agreements.With these agreements, the Fed buys securities from a primary dealer, and the dealer agrees to buy them back at a given price at a specified future date, usually within one week.
In effect, the government securities serve as collateral for a short-term loan. For defensive open market sales, the trading desk often engages in matched sale–purchase transactions (sometimes called reverse repos), in which the Fed sells securities to primary dealers, and the dealers agree to sell them back to the Fed in the near future.
Economic disturbances, such as natural disasters, also cause unexpected fluctuations in the demand for currency and bank reserves. The Fed’s account manager must respond to these events and sell or buy securities to maintain the monetary policy indicated by the FOMC’s guidelines.
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