I’ve read that the central bank performs open market operations in order to decrease or increase interest rates. What the central bank does is it buys government securities from selected banks if it wants to decrease interest rates, and it sells government securities if it wants to increase interest rates.
What I don’t understand is how these open market operators actually decrease or increase interest rates. Can you please enlighten me?
Based on the law of supply and demand. If the government is trying to issue debt and nobody will buy any at X rate, the rait rises to intice more people to purchase the debt. If there are many buyers the rate falls. The Fed is a buyer of these securities so they make up a portion of the demand.
In the specific case of the Federal Reserve, there are the following ways through which it can set or manipulate interest rates:
It can directly set what’s called the discount rate*,* which is the interest rate for borrowing money directly from the Fed.
It can manipulate the federal funds rate, which is the interest rate for borrowing money from other member banks. The Fed manipulates this rate by conducting so-called open-market operations, which basically involve the buying and selling of federal-government bonds.
Even less directly, it can manipulate interest rates by raising or lowering the reserve requirement, which is the required percentage of cash that member banks must hold against account balances.