How Are Open Market Operations Related to Other Monetary Instruments?
Open market operations affect the money supply and related financial measures through their impact on the reserve base of the banking system. As a matter of monetary policy tactics in controlling these reserves, open market operations can be conducted in one of two ways: actively, by aiming for a given quantity of reserves and allowing the price of reserves (that is, the interest rate) to fluctuate freely; or passively, by aiming at a particular interest rate, allowing the amount of reserves to fluctuate. Industrial countries, with well-developed and sensitive markets, normally employ a passive approach, although there have been exceptions. A passive approach also appears to be the norm in emerging markets that have reached a certain level of sophistication. There are advantages to a more active approach in developing countries, however. In such countries, the absence of efficient secondary or interbank markets--to transmit the influence of monetary policy--might be one reason for an active approach. Another might be that the active approach allows the central bank to define its policies more clearly, especially when control of inflation is the overriding goal. Such an approach is embodied in a number of programs supported by the International Monetary Fund for particular countries.
If open market operations are to become the principal policy instrument, other monetary instruments obviously need to be given less importance, particularly the central bank's discount window, where the banking system can obtain reserves on its own initiative simply by borrowing from the central bank. Other adjustments may also be needed, depending in part on the particular strategy adopted for conducting day-to-day ...