To
translate its policy decision about the money supply into action,
the FOMC authorizes the New York district bank to trade securities
on the open market. What that means, in practice, is that the
Fed either buys government bonds from banks or customers of banks
or sells bonds to banks or their customers.
The Fed buys to increase the
money supply
and sells to decrease the money supply.
When it buys, it credits the reserve account
of the bank that sells the bonds, increasing the reserves that
bank has available to lend. When the subsequent lending occurs,
more money goes into circulation. As borrowers spend what is loaned
to them, the money is deposited and redeposited in other banks,
which then have additional reserves to make loans themselves.
When the Fed sells, it debits the cost of
the bonds a bank buys from the bank’s reserve account, reducing
the amount the bank has available to lend.
What's for sale?
Though the Fed is authorized to conduct open market operations by buying or selling any type of security, such as stock or corporate bonds, it traditionally trades only U.S. government bonds.
