Indicators such as inflation, interest rates and exchange rates are used in open market transactions.

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✪ "Banking, Part 13: Open Market Operations"

✪ "Federal Reserve. Open Market Operations"

✪ "Open Market Operations and Analysis of Quantitative Easing"

Subtitles

Last time I mentioned that in this video we will discuss the elasticity of the money supply. We can call it the money of bank turnover. I suppose the first question that arises is why do this? Let's assume that we are already in this world and we only have two banks. And the money supply D1 is equal to $400. Thus, you are unlikely to want to play with regulatory reserves. So I have Treasury securities and let it be the central bank.

Process

Since most money today exists in electronic form rather than in the form of notes and coins, open market transactions are carried out by increasing ( lending) or decrease ( debiting) the volume of base money (monetary base) in a bank's reserve account at the central bank. Thus, the process does not require printing new currency. However, it increases the central bank's obligation to print money if a commercial bank requires notes in exchange for reducing the electronic balance.

When there is increased demand for base money, the central bank must take action if it wishes to keep short-term interest rates at target. It does this by increasing the supply of base money. The central bank goes to the open market to buy a financial asset (government bonds, foreign currency, or other relatively stable assets). To pay for an asset, the central bank creates new base money and credits the account of the bank selling the asset with it. This increases the monetary base in the economy. Conversely, if the central bank sells assets on the open market, a corresponding amount of base money is debited from the buying bank's account, thus reducing the base money.

Possible goals

Money is created and destroyed by changing a commercial bank's reserve account at the Federal Reserve. The Federal Reserve has conducted open market operations since the 1920s through the Open Market Division of the Federal Reserve Bank of New York under the authority of the Federal Open Market Committee. Open market operations are also a way to control inflation: selling government bonds to commercial banks reduces their ability to lend, thereby taking some money out of circulation.

A tool for flexible and prompt influence on the volume of liquid resources of commercial banks is open market operations. Open market operations refer to the buying and selling of government securities to change the money supply. By regulating the supply and demand for government securities, the effect of fluctuations in the volume of money supply in circulation is achieved, caused by the nature of the response actions of commercial banks. Thus, the sale by a commercial bank of government chain securities narrows the free resources of the commercial bank for lending purposes, and the purchase, on the contrary, frees up resources and increases lending opportunities.

Conducting operations on the open market, known as open-market policy, began to be used since the 20s. XX century in the USA. The German bank carried them out since 1933, Great Britain - also in the 30s. Open market policies quickly gained popularity due to their high efficiency and flexibility, displacing other methods of monetary regulation.

Reducing the lending capabilities of commercial banks is advisable during periods of high market conditions, and increasing them during times of crisis. In a crisis situation, the central bank creates the possibility of refinancing for commercial banks. It puts them in a situation where selling securities to the central bank becomes profitable. There is a simultaneous change in the lending interest and liquidity of commercial banks. At the same time, purchasing securities from the Central Bank is advisable when there is low demand for commercial bank loans from firms and households. At the same time, the conditions of the central bank for the purchase of securities should be more favorable than the conditions for providing loans to the population and enterprises of the non-financial sector.

The success of the open market policy is facilitated by the development of financial market institutions in the West. Here, central banks operate alongside other lending institutions, including savings and investment companies and businesses. A strong liquidity reserve of commercial banks confirms its financial activity and can be ensured as high

Chapter 8. Monetary regulation

both profits and a large portfolio of high-yield securities.

There may be some differences in conducting open market transactions. Traditionally, the Bank of Germany sets the interest rates at which it is willing to buy securities. However, sales volume is not subject to regulation. On the contrary, in the USA and England, the Central Banks determine the volumes of purchase and sale, in accordance with which commercial banks will purchase securities from them. The interest rate here is determined indirectly and depends on the period for which government securities are placed.

The operation of purchasing securities on the terms of a reverse transaction has also found application in the implementation of open market policies. In this case, the Central Bank purchases securities from commercial banks for a period, after which commercial banks repurchase the sold securities at a discount, i.e. at a discount relative to the price of the original transaction. REGU transactions are carried out, which are also used in the relationships of commercial banks with clients. Here, one-day or term repurchase agreements involve the sale of highly liquid securities to banks (in the United States - the Treasury or a federal agency) on the terms of their redemption on another day (overnight) or for a longer period (from a week to a month) at a higher price. The premium to the value of the initial transaction constitutes the income of the commercial bank that provided credit to the client on the security of the transferred securities.

Carrying out an effective open market policy in the Russian Federation requires expanding the capacity of the financial market and adequate functioning of its mechanisms.

In the West, at different times, the main instruments for pursuing an open market policy were:

Treasury bills;

Government and local government debt obligations;

Interest-free treasury certificates;

Debt obligations admitted to exchange trading;

Special bills.

According to experts, after August 1998 the Bank of Russia was faced with the task of developing a mechanism for restoring financial

Part III. Banking intermediation: institutions and organization

of the new market, since open market operations are an important tool for regulating the liquidity of the banking system. Under these conditions, the Central Bank offered the market its own short-term zero-coupon bonds of Russia - OBR. These bonds are short-term in nature: circulation period is up to 3 months, maximum issue volume is 10 billion rubles. The Central Bank has provided commercial banks with the opportunity to use them as collateral for pawnshop, intraday and overnight loans.

At the stage of recovery of the financial market, the importance of the regulatory activities of the Central Bank of the Russian Federation increases. The government securities market should acquire a new qualitative level, expressed in the predictability of its dynamics and a reduction in the share of speculative transactions carried out. Securities that require a differentiated approach will be traded on it, for example:

Securities issued for the restructuring of GKO-OFZ;

New public debt instruments.

The circulation of municipal securities will continue, the prospects of which will largely be determined by the state of the regional economy and finances.

The position of the market for foreign currency government securities (Eurobonds, domestic foreign currency loan bonds, etc.) will only improve with an increase in Russia's credit rating. Assuming the gay to activate the sector of corporate debt obligations - mortgage-backed bonds, commercial bills, etc., which will allow for the transfer of capital from government securities into the corporate segment.

Cm." Fundamentals of banking (Banking) / Ed. K. R. Tagirbekova M.: INFRA-M; Publishing house "The Whole World", 2001. P. 92..

Related information.

Government securities

Government securities include securities of the Russian Federation and securities of constituent entities of the federation. Thus, government securities of the Russian Federation include securities that are issued on behalf of the Russian Federation, and government securities of a constituent entity of the Russian Federation include those securities that are issued on behalf of a constituent entity of the Russian Federation.

Government securities are issued in the form of bonds or other securities that are classified as issue-grade securities according to the Law on the Securities Market.

Such securities confirm the right of their owner to receive from the issuer of the specified security funds or other property in accordance with the terms of the issue of these securities, as well as certain percentages of the nominal price or other property rights within the period stipulated by the terms of such issue.

Note 1

The Central Bank has the right to carry out transactions only with a certain list of securities that meet reliability requirements. Traditionally, the state is considered to be the most reliable issuer, which cannot fail to pay off its obligations. Therefore, government securities are particularly attractive to various investors. However, world practice is such that the high reliability of such securities is accompanied by the lowest profitability.

Characteristics of government bonds

Definition 1

A bond is an issue-grade security that secures the right of its owner to receive from its issuer its nominal price or other property equivalent within the time period established in the bond.

The terms of the issue (issue) of a bond may provide that its owner acquires the right to receive a percentage of its nominal value fixed in the bond or other property rights. The income on the bond is a discount and/or interest.

The Ministry of Finance may issue securities:

1. In the form of bonds denominated in rubles (federal loan bonds, short-term government bonds);
2. In the form of bonds denominated in foreign currency (bonds of external bonded loans, bonds of state foreign currency bonded loan);
3. In the form of treasury bills.

Note 2

Government bonds are part of the government debt.

So bonds denominated in rubles are part of the domestic debt, bonds denominated in foreign currency are part of the external debt. At the legislative level, a number of additional conditions are defined that are mandatory in the case of the issue of government bonds. This is necessary to control the volume of public debt. Representative bodies of state power and local self-government bodies set the maximum volume of bonds issued by the corresponding level of government.

Central Bank operations with government bonds

The central bank's buying and selling operations of government transactions are classified as open market operations.

Note 3

At the legislative level, the powers of the central bank are enshrined in participating in organized trading, buying and selling not only government issued and non-issued securities, but also its own securities - bonds of the central bank issued by it as a legal entity.

The activities of the Central Bank in the securities market are one of the most effective instruments of monetary policy and the most important function of the central bank.

The Central Bank of Russia, within the framework of its purchase and sale transactions with government bonds at organized auctions, functions as a professional participant in the securities market and carries out brokerage activities in terms of purchasing and selling government bonds on behalf of the Russian Federation.

State management of a market economy involves guaranteed support by the Central Bank of Russia for the activities of commercial banks. This is due to the fact that the latter are the working link of the monetary system, directly organizing credit relations in the national economy in the real sector of the economy.

Let's consider the main tools with which the Central Bank carries out its policy on the open market. These include, first of all, changes in the refinancing rate, changes in required reserve norms, open market transactions with securities and foreign currency, as well as some measures of a strict administrative nature.

If we talk about refinancing, then refinancing means lending by the Central Bank of Russia to banks and credit institutions to regulate the liquidity of the banking system.

The forms, procedure, terms, conditions and limits of refinancing are established by the Bank of Russia. Federal Law of the Russian Federation “On Banks and Banking Activities” dated February 3, 1996

The refinancing rate is a tool of monetary regulation, with the help of which the Central Bank influences the rates of the interbank market, as well as rates on deposits of legal entities and individuals and loans provided to them by credit institutions.

The limit on open market operations is approved by the Board of Directors.

Open market operations vary depending on:

• - terms of the transaction: purchase and sale for cash or purchase for a period with mandatory re-sale - reverse transactions;
• - objects of transactions: transactions with government or private securities;
• - urgency of the transaction: short-term (up to 3 months), long-term (up to 1 year or more) transactions with securities;
• - areas of operations: only in the banking sector of the securities market or in the non-banking sector of the market;
• - method of setting rates: determined either by the Central Bank or the market.

Open market operations first began to be actively used in the USA, Canada and the UK due to the presence of a developed securities market in these countries. Later, this method of credit regulation was widely used in Western Europe.

According to the form of market transactions of the Central Bank with securities, they can be direct or reverse. A direct transaction is a regular purchase or sale. The reverse operation consists of the purchase and sale of securities with the obligatory completion of a reverse transaction at a predetermined rate. The flexibility of reverse operations and the softer effect of their impact make this regulatory instrument popular. Thus, the share of reverse operations of the Central banks of leading industrialized countries on the open market reaches from 82 to 99.6%. If you look at it, you can see that in essence these operations are similar to refinancing against securities. The Central Bank invites commercial banks to sell it securities on terms determined on the basis of auction (competitive) trading, with the obligation to sell them back in 4-8 weeks. Moreover, interest payments accruing on these securities while they are in the ownership of the Central Bank will belong to commercial banks.

Thus, open market operations are the use of more flexible regulation, since the volume of securities purchased, as well as the interest rate used, can change daily in accordance with the direction of the Central Bank's policy. Commercial banks, taking into account the specified feature of this method, must closely monitor their financial position, while avoiding a deterioration in liquidity.

In fact, the Central Bank of Russia performs the functions of an agent of the Ministry of Finance of the Russian Federation for servicing, as well as a regulatory and control body.

The Central Bank of Russia provides the “organizational” side of the functioning of the government short-term bonds (GKO) market: it conducts auctions, redemptions, prepares the necessary documents, and transfers the necessary funds to the account of the Ministry of Finance of the Russian Federation. In addition, he actively participates in the work of the GKO market as a dealer, which makes it possible to have a targeted economic impact on the market depending on the events that occur directly in and around him, and in accordance with the current policy of the Central Bank.

At the same time, the Bank of Russia does not set as its goal making a profit from operations on the market. The Central Bank is focused on maintaining a certain level of certain indicators of the GKO market, which determines the attractiveness of the GKO market for investors.

The fundamental purpose of the Central Bank's open market operations is to help the Russian economy achieve an overall level of output characterized by full employment and price stability.

The Central Bank, with the support of the state, has the opportunity to provide the payment system with powerful telecommunications tools necessary for settlements by market participants. The Central Bank is able to register all payment transactions occurring between banks and efficiently offset the mutual obligations of banks.

The Central Bank pursues a discount rate policy (sometimes called a discount policy), acting as a “lender of last resort.” It provides loans to the most financially stable banks experiencing temporary difficulties. The Federal Reserve System (Fed) sometimes makes long-term lending under special conditions. These could be loans to small banks to meet their seasonal cash flow needs. Sometimes loans are also provided to banks that find themselves in difficult financial situations and need help to get their balance sheets in order.

Interest rates of the Bank of Russia represent the minimum rates at which the Bank of Russia carries out its operations.

The Bank of Russia may set one or more interest rates for various types of transactions or pursue an interest rate policy without fixing the interest rate.

The Bank of Russia uses interest rate policy to influence market interest rates in order to strengthen the ruble (Article 37). Federal Law on the Central Bank of the Russian Federation (Bank of Russia) (as amended by Federal Laws dated April 26, 1995 No. 65-FZ, dated December 27, 1995 No. 210-FZ, dated December 27, 1995 No. 214-FZ, dated June 20, 1996 No. 80- Federal Law, dated February 27, 1997 No. 45-FZ).

Carrying out macroeconomic supervision over the functioning of the banking system as a whole, as well as supervision over the activities of each bank separately, the Central Bank can quickly take preventive measures to stabilize the financial situation of participants in the payment services market and carry out the rehabilitation of a particular problem bank in order to prevent a break in the links of the settlement chain due to bankruptcy or illiquidity of its participants.

The Central Bank of the Russian Federation considers the main task of monetary policy on the open market to be reducing inflation while maintaining and possibly accelerating GDP growth while simultaneously creating the prerequisites for reducing unemployment and increasing real incomes of the population.

OPERATIONS OF CENTRAL BANKS ON THE OPEN SECURITIES MARKET

S. R. MOISEEV

Moscow State University of Economics,

statistics and computer science

Unlike reserve requirements, open market operations (OOPs) are a highly flexible monetary policy tool that are used on a voluntary rather than a coercive basis. OOPs can be carried out with any frequency and volume of assets, due to which they act as an effective means of managing money supply and liquidity in the banking sector. In addition, OOPs are a good way to encourage competition in the financial system.

INTRODUCTION TO OPEN MARKET OPERATIONS

Open securities market operations involve the purchase and sale of securities in order to increase or decrease the amount of funds available to financial institutions. First of all, OOP affects bank reserves, and also, through the multiplier effect, affects the supply of credit and economic activity in general. OOP can be carried out both in the primary market (through issues of securities) and in the secondary market. In the primary market, transactions are carried out when financial markets are not yet sufficiently developed. Gradually, with the establishment and liberalization of the financial system, the main focus of OOP has shifted to the secondary market, which provides greater operational flexibility for the central bank. The object of OOP are marketable securities, such as debt obligations of the state treasury (Ministry of Finance), state corporations, major national corporations and banks.

OOP uses various technical procedures, which allows them to be classified in a variety of ways:

According to the terms of the transactions (direct operation or purchase and sale for a period with an obligation to repurchase on pre-agreed conditions);

By objects of transactions (transactions with government or private securities);

By the urgency of transactions (short-, medium- and long-term);

By counterparties (banks, non-banking institutions, financial sector as a whole);

By fixing the interest rate (by monetary authorities or the market);

By fixing the volume of OOP (by monetary authorities or the market);

On the initiative of concluding a transaction (by monetary authorities or the market).

Open market operations are the main instrument of monetary policy in industrial countries and are now becoming increasingly important for developing countries and transition economies. OOPs allow central banks to enter into transactions on their own initiative, that is, to be more flexible in the timing and volume of monetary transactions. They also encourage impersonal business relationships with market participants and move away from ineffective direct control. The development of indirect instruments of monetary policy is one of the most important moments in the process of economic development, due to the fact that as the country's markets develop, direct instruments lose their effectiveness, because markets ultimately find ways to circumvent restrictions, especially when is about international operations.

Open market operations affect the supply of money and credit through their impact on the reserve base of the banking system. As a monetary policy tactic in managing bank reserves, OOP can be carried out in one of two ways: (1) active: fixing the volume of reserves and freely determining the price of resources (i.e. the interest rate); or (2) passive: fixing the interest rate while varying the volume of reserves. Industrial countries with well-developed money markets typically take a passive approach, although there have been exceptions in the past. A passive approach is now also becoming the norm for emerging markets that have reached some level of development. Nevertheless, in the author’s opinion, in developing countries there is every reason to use

using an active approach. In such countries, the lack of effective secondary or interbank money markets - designed to transmit the effects of monetary policy - may be one reason for using an active approach. Another reason is that a proactive approach allows the central bank to define its policies in a transparent and open manner. The active approach is implemented in many stabilization programs in developing countries supported by the IMF.

OBJECTS OF OPEN MARKET OPERATIONS

During OOP, the central bank prefers securities that have maximum liquidity and minimum credit risk. Liquidity of securities is an important aspect of intervention for several reasons. To effectively implement monetary policy, manage assets and liabilities, and fully perform the functions of lender of last resort, the central bank needs to ensure that during OOP, distortions in securities prices are as small as possible. As a rule, any securities actively traded on the secondary market have sufficient liquidity. Of these, the most suitable for monetary authorities are those for which the credit risk is insignificant, that is, the likelihood of the issuer failing to fulfill its obligations is extremely low. Considering both criteria for selecting securities, most central banks chose government securities. They perform several functions in the activities of the central bank. First, securities are used in managing the liquidity of the financial system. Secondly, they serve as collateral that supports the smooth operation of payment and clearing systems. Thirdly, foreign securities act as an asset of the monetary authorities, covering the issue of the national currency.

In addition to purely operational considerations, the selection of securities is also influenced by the degree of development of financial markets and the independence of the central bank. In many countries, the securities market has not yet developed sufficiently to allow OOP to be carried out effectively. In a number of industrialized countries, the implementation of a program to reduce public debt or a budget surplus makes it possible to do without borrowing on the debt market. According to OECD statistics, the volume of market securities

mag issued by industrialized countries (except Japan) fell over 1995-1999 from 45 to 40% of GDP. In order to solve the problem of shortage of OOP objects, central banks issue their own securities. The most common types of obligations issued by monetary authorities are:

> debt certificates (Bank of the Netherlands,

National Bank of Denmark, Bank of Spain,

European Central Bank);

> financial bills (Bank of England, Swedish

Riksbank, German Bundesbank, Bank of Japan);

> bonds (Bank of Korea, Central Bank

Chile, Bank of Russia).

However, most central banks refuse to issue their own securities for several reasons. They seek to avoid the emergence of market fragmentation and support government securities as a basic guide for financial market participants. By using not their own securities, but the obligations of the fiscal authorities, central banks thereby isolate themselves from unnecessary interference in the sphere of financial intermediation. In addition, monetary authorities minimize the risk that may be imposed on the private sector in the form of distorted prices of financial assets resulting from the selection of a particular asset as an object of public investment.

Another important aspect of the selection of OOP objects is the independence of the central bank. If non-government securities are chosen as targets for intervention, the central bank may be accused of disloyalty and protectionism towards certain issuers. To avoid such scandals, monetary authorities limit their choice to government securities.

Table 1 provides a comprehensive overview of central banks' OOP targets. Government securities used in interventions are included in the assets of central banks, and their own securities are included in liabilities. The stock portfolio of most central banks consists of debt obligations of foreign governments and domestic fiscal authorities, supranational agencies and financial institutions. All of them are actively traded on the market and have a high credit rating. From an OOP perspective, two factors influence the balance sheet structure of central banks. First, the openness of the economy and its dependence on the dynamics of the exchange rate of the national currency lead to a larger share of foreign reserves in

Table I

Balance sheet structure of central banks of the world's leading countries, %

Source: Zelmer M. Monetary Operations and Central Bank Balance Sheets in a World of Limited Government Securities. IMF Policy Discussion Paper No. 7, 2001. - P. 6.

Central Bank Net Debt securities issued Credit financial Other

loans to foreign institutions

assets government financial institutions other institutions Repo Lombard loans

Reserve Bank 65 9 0 0 26 1 0

Australia

Bank of Canada 4 85 4 0 4 2 0

National Bank 52 7 11 0 0 29 1

European 39 10 1 1 47 0 2

central bank

Central Bank of Iceland 23 5 4 0 64 3 1

Bank of Japan 4 60 0 12 19 1 4

Reserve Bank 3 50 0 0 47 0 0

New Zealand

Central Bank 94 2 0 0 0 4 0

Norway

Swedish Riksbank 66 13 0 0 21 0 0

Swiss 75 1 1 2 21 0 0

National Bank

Bank of England 0 5 0 2 53 2 39

US Federal Reserve 5 88 0 0 7 0 0

Central Bank Cash Deposits Own Others

in circulation of financial governments of other valuable net items

institutions paper institutions

Reserve Bank 47 1 27 1 0 24

Australia

Bank of Canada 96 5 0 1 0 -1

National Bank 20 20 17 3 23 16

European 43 30 6 0 0 21

central bank

Central Bank 12 34 15 6 0 32

Iceland

Bank of Japan 60 6 23 0 5 6

Reserve Bank 46 1 42 1 0 9

New Zealand

Central Bank 8 4 80 0 0 9

Norway

Swedish Riksbank 45 2 0 0 0 53

Swiss 30 5 9 0 0 56

National Bank

Bank of England 78 6 1 13 0 2

US Federal Reserve 95 3 1 0 0 1

assets and, as a consequence, to a significant share of foreign debt in the portfolio of central banks. The most striking examples are demonstrated by the monetary authorities of Norway, Australia and Denmark. Secondly, depending on the specifics of short-term refinancing of the financial system, the assets of the monetary authorities contain more loans or securities. Especially-

The performance of payment systems, the efficiency of the money market and the tradition of refinancing determine whether the financial sector is regulated through the securities market or the discount window. In Denmark, the eurozone and Iceland, refinancing is carried out through a discount window, and in Japan, Canada, and the USA - through the stock market.

table 2

Open market operations of central banks of the world's leading countries

Source: Zelmer M. Monetary Operations and Central Bank Balance Sheets in a World of Limited Government Securities. IMF Policy Discussion Paper No. 7, 2001. - P. 7.

Central Bank Peno Direct transaction Bill discounting Currency swap Lombard loan Issue of own securities

Reserve Bank of Australia Yes No No Yes Yes No

Bank of Canada Yes Yes No No Yes No

National Bank of Denmark No No No No Yes Yes

European Central Bank Yes No No No Yes No

Central Bank of Iceland Yes No No No Yes No

Bank of Japan Yes Yes Yes No Yes Yes

Reserve Bank of New Zealand Yes No No Yes Yes No

Central Bank of Norway Yes No No No Yes No

Swedish Riksbank Yes No No No Yes No

Swiss National Bank Yes No No Yes Yes No

Bank of England Yes Yes No No No No

US Federal Reserve Yes Yes Yes No No No

In table Table 2 shows the main OOPs carried out by central banks of developed countries. As it follows, most central banks prefer to use peno and pawn credit instead of direct transactions (outright operations). In both cases, financial institutions pledge financial assets to the monetary authorities or temporarily transfer ownership of them. The differences between peno transactions and pawn loans are primarily legal rather than economic. For example, in the European System of Central Banks, an OOP may be defined as a peno or pawn loan depending on the legal status of the financial institution. For example, in Germany all OOPs take the form of a security pledge, while in France the same transactions are identified as peno transactions.

Most central banks prefer to use government securities or government-guaranteed obligations in peno operations (Table 3). As a rule, monetary authorities prefer not to create a peno market “from scratch”, but resort to the private peno market, where transactions with government securities are already being actively concluded. In addition to government obligations, central banks use private securities in pawnshop and rediscount operations. This partly reflects the fact that most deals are concluded in one

day. With the help of ultra-short-term loans, banks smooth out the deficit or excess of funds when completing settlements of payment systems at the end of each working day. For overnight transactions, where financial risks are minimal, private rather than government securities are quite suitable.

In all transactions where banks pledge securities to the monetary authorities, the amount of collateral must be greater than the amount of the loan. The initial margin protects the central bank from unwanted changes in the value of the pledged financial asset. To ensure that possible adverse consequences for the monetary authorities are as minimal as possible, additional requirements have been established for private securities. These may be a minimum external credit rating (Canada and Japan) or a minimum reliability threshold established within the central bank's internal credit review system (the European System of Central Banks). In some cases, monetary authorities pre-determine the list of securities suitable as collateral (Sweden, Great Britain).

Not all central banks resort to classic OOP with securities. Monetary authorities in open economies are also forced to operate in the foreign exchange market. For example, the Reserve Banks of Australia and New Zealand use currency swaps in addition to traditional

Table 3

Objects of open market operations of central banks of the world's leading countries

Source: Zelmer M. Monetary Operations and Central Bank Balance Sheets in a World of Limited Government Securities. IMF Policy Discussion Paper No. 7, 2001. - p. 8.

Central Bank Government Securities Government Agency Securities Mortgage-Based Securities Financial Institution Securities Industrial Private Sector Securities Foreign I Securities

Reserve Bank of Australia Yes Yes

Bank of Canada Yes

European Central Bank Yes Yes Yes Yes Yes

Central Bank of Iceland Yes Yes

Bank of Japan Yes

Reserve Bank of New Zealand Yes

Swedish Riksbank Yes Yes Yes

Swiss National Bank Yes Yes Yes Yes

Bank of England Yes Yes Yes Yes

US Federal Reserve Yes Yes Yes

Pawn loan |

Central bank Government securities Government agency securities Mortgage-backed securities Financial institution securities Industrial private sector securities Foreign securities

Bank of Canada Yes Yes Yes Yes Yes No

National Bank of Denmark Yes Yes Yes No No No

European Central Bank Yes Yes Yes Yes Yes No

Central Bank of Iceland Yes Yes No No No No

Bank of Japan Yes Yes No No Yes Yes

Reserve Bank of New Zealand Yes Yes Yes Yes Yes Yes

Swedish Riksbank Yes Yes Yes Yes Yes Yes

Swiss National Bank Yes Yes Yes Yes Yes Yes

Direct deal

Central Bank Government securities. Government agency securities Mortgage-backed securities Financial institution securities Industrial private sector securities Foreign securities

Bank of Canada No No No Yes No No

Bank of Japan Yes No No No No No

Bank of England Yes Yes No Yes No No

US Federal Reserve Yes Yes No No Yes No

collateral instruments. In the past, when the national money markets operated with currency swaps were not yet sufficiently developed, and the supply of government securities was not yet sufficiently developed in Norway.

RELATIONSHIP OF OPEN MARKET OPERATIONS WITH OTHER MONETARY POLICY INSTRUMENTS

For OOPs to become an integral part of national monetary policy, other monetary instruments must be appropriately adapted and market infrastructure transformed. Let's look at how OOP relates to other monetary instruments. If OOP is to become the main policy instrument of the monetary authorities, other monetary instruments should be given less importance, especially the discount window through which the banking system obtains reserves by borrowing from the central bank. For OOPs to be effective, restrictions must be placed on banks' access to central bank credit. Without such restrictions, OOP cannot be used as the main instrument of monetary policy to manage liquidity in the financial sector of the economy. For this reason, the discount window must be configured in a special way to make market access to credit of last resort less attractive, for example through a high penalty rate or restrictive credit guidelines. Some countries, such as Germany, use a double rate mechanism consisting of a basic discount rate and a penalty pawn rate to discourage loan abuse.

At the same time, restrictions on the discount window should be used with caution. If the penalty rate is set much higher than current market conditions, the refinancing system will not be able to respond quickly enough to the sudden demand for liquidity. Short-term refinancing principles that take into account limited access to the window should allow for gradual, smooth adaptation to conditions of reserve shortages. For example, central bank loans can be divided into ultra-short-term loans, which eliminate liquidity shortages, and long-term structured loans through the discount window, which, among other things, allow banking institutions to obtain the necessary funds in a critical situation.

In addition to the discount window, central banks have traditionally used reserve requirements as a means of monetary regulation. Reserve requirements can be considered either as an alternative to OOP, or as a tool for increasing their effectiveness in terms of

meeting the goals of monetary regulation. Since the use of OOP has become widespread, central banks have resorted much less to changing the reserve ratio. In many countries they have been gradually reduced and in some cases eliminated entirely because reserve requirements make banks less competitive with other financial institutions.

A minimum, but not zero, level of reserve requirements may be necessary to assess the impact of OOP on interest rates and money supply. The experience of some countries, such as the UK, which have not resorted to reserve requirements, suggests that they are not absolutely necessary. On the other hand, financial crises such as the Mexican crisis in late 1994 have shown that reserve requirements are still useful in stabilizing market conditions. Even in the US, with its highly developed money market, reserve requirements remain mandatory for transaction deposits.

PUBLIC DEBT MANAGEMENT

It is clear that government decisions regarding debt management and deposit balance management affect OOP. Sometimes they can make operations easier, and in other cases they can make it more difficult. In all countries, the treasury and the central bank coordinate their actions, although with varying degrees of intensity and effort. In most cases, the final decision on debt management is made by the Treasury, with the central bank acting as its agent. In areas where government operations have a direct effect on bank reserves, the central bank has a strong say. Working relationships may differ depending on the traditions and financial history of the country.

In any case, OOP will be most effective where the central bank controls the factors affecting the reserve base of the banking system. In order to maintain a clear separation of monetary and fiscal policy operations, it is desirable that government debt issued for fiscal purposes be sold in the market by the Treasury, to avoid any conflict between government debt management and monetary policy needs. Such issuances should take the form of auctions, helping to develop a competitive, deregulated market system. This also avoids pressure

influence on the central bank in terms of supporting the placement of securities on the primary market at a predetermined rate. From an OOP perspective, it is particularly important for the central bank to influence—if not control—the Treasury operating balance, the fluctuation of which affects the supply of bank reserves.

It is highly unusual for a central bank to have the discretion to regulate government deposits, but there are a number of such examples around the world. The Bank of Canada, for example, has the power to transfer government deposits between its own balance sheet and the balance sheet of commercial banks. For the Malaysian Bank Negara, auctions of government deposits are a traditional tool of monetary policy. The German Bundesbank has veto power over government decisions to place deposits outside its balance sheet.

In general, OOPs will function effectively when the government adheres to, and the public believes in, a clear separation of debt management and monetary policy operations. In practice, this usually involves an agreement to neutralize the monetary effect of the treasury balance sheet or to delegate its management to the central bank. In virtually all countries, decisions regarding debt management are implemented through the central bank, both formally and informally.

IMPLEMENTING OPEN MARKET OPERATIONS IN DEVELOPING COUNTRIES

As national economies grow, financial markets expand and deepen. Their formation, as a rule, actively requires the guidance of the government and monetary authorities. Associated with the formation of the financial market, the development of monetary policy instruments on the open market usually occurs in two stages. First, through auctions of new issues of securities in the primary market, there is a shift from direct control to the use of OOP. At the second stage, with the development of secondary markets, there is a complete transition to flexible bilateral transactions with marketable securities in the secondary market.

Ideal conditions for effective implementation of OOP exist in only a few developing countries and transition economies. Nevertheless, OOP of one kind or another can and should be carried out in markets that are not yet fully ready and are at the stage of transformation. In such cases, OOP needs to be

limit in size or use on an off-period basis rather than on a regular basis. The participation of the central bank in the formation of the financial system, on the one hand, should accelerate the development of the market, and on the other hand, should not expose its balance sheet to risks, which could reduce confidence in the monetary authorities. A central bank will be able to intervene successfully if markets have confidence that its asset portfolio is highly liquid and risk-free.

The most suitable markets for OOP in developing countries are usually those in which short-term instruments are traded. Well-developed markets are characterized by large and sustained trading volumes involving a variety of players, including governments, financial institutions and other businesses. Three sectors present the best opportunities for effective OOP. These include government and central bank securities markets, the interbank debt market, and short-term instruments issued by financial institutions and other corporations, including commercial and financial bills and bank certificates of deposit. Given the government's ability to manipulate fiscal policy and quickly raise its revenues when necessary, the government securities market is generally seen as the most favorable environment for OOP in developing countries. Unstable political and economic conditions, however, may make it impossible for the government debt market to function properly. For the OOP to be carried out effectively, it is critical that the government strictly adheres to debt interest payments as well as debt repayments. The government securities market can be plunged into collapse not only due to refusal to fulfill contractual obligations, but also due to the pro-inflationary policies of the monetary authorities, which lead to investors fleeing the market.

Short-term private debt, including interbank liabilities, is less suitable for OOP. In developing countries it is characterized by specific credit risks. In addition, the use of private securities as a target for intervention forces the central bank to make difficult choices when conducting monetary policy. If the central bank buys private debt, businesses may be willing to issue riskier securities. And if the central bank suddenly refuses to buy them, players could

completely turn away from such securities, which will provoke a money market crisis. One of the options for solving this problem is for the monetary authorities to limit their operations to securities that have the maximum credit rating established by an independent rating agency. In an environment where government debt is low or rapidly declining, the central bank may find it has no choice but to switch to private money market instruments. When this occurs, transactions in commercial bank instruments or interbank obligations are much less problematic from a credit risk perspective than transactions in other private instruments. If the government debt market has not yet reached the required volume, the central bank can influence the banking system through specialized issues of government securities intended only for monetary policy purposes.

The central bank can also promote market development by introducing operating principles or codes for its counterparties. First of all, it is necessary to identify a circle of business partners. The criterion for a business relationship with the central bank may include membership in a dealer group. Many countries conduct OOP through primary dealers, who have an obligation to provide bid and offer quotes for securities when the central bank enters the market and during Treasury auctions. Brazil, the Czech Republic, India, Malaysia, the Philippines, Poland and Russia (until 1998), for example, introduced primary dealer systems. To perform their functions more effectively, dealers must seek retail customers, thereby helping to develop a wider and more liquid market.

In small countries, establishing a primary dealer system, where the number of participants may be insufficient, is problematic and often impractical. However, when the market becomes large enough, there are many incentives to limit the operations of a group of dealers, for example through minimum equity capital requirements. To avoid accusations of favoritism, the dealer group may have to be quite large. By establishing a dealer group, the central bank will benefit in terms of encouraging dealers to apply better market making standards, such as minimum transaction size for trades at quoted prices.

As already mentioned, to conduct effective OOP, both the central bank and the government need a developed government securities market infrastructure. It must have sufficient transparency for wide participation of various categories of players, as well as minimal counterparty risks. To achieve this quality of the market, the central bank needs to set standards for the performance of its participants. To do this, he will naturally need to observe the market by collecting statistics and publishing market summaries. Of course, the central bank can do without additional functions if it resorts to direct regulation and mandatory market supervision. However, such steps will force him to increase his staff, follow the path of red tape and, ultimately, loss of efficiency and trust. The solution to the problem lies in a clear separation of powers and responsibilities relating to monetary policy operations (the responsibility of the monetary authorities) and regulatory operations (the responsibility of some other agency or, if within the central bank, a department separate from the OOP).

STIMULATING THE DEVELOPMENT OF MARKET ARCHITECTURE

Any central bank prefers to operate in an efficient market, in which trading occurs continuously and where the speed of market response is high. Monetary authorities can take certain steps to develop the interbank market, engineer market instruments and trading infrastructure, provide financing facilities, set dealing criteria, collect and disseminate statistics, and promote a secure payment and clearing mechanism.

The Central Bank is the center for the collection and dissemination of market statistics. The process of collecting data, including daily information on positions, volume of transactions and financing by type of issue, should begin in the early stages of market development. Statistics provide the basis for observation. Later, when the number of participants is so large that data on an individual company or bank cannot be published, the central bank must release aggregate data on market activity. Publication must be delayed with a sufficient lag, for example a week or

month, depending on the instrument, to avoid market overreaction.

The central bank should also take the initiative early in market development to introduce payment and delivery standards. No market operates without a guarantee that securities will be delivered on time and paid for as agreed. While the speed and reliability of clearing and payment systems obviously depends on the technological capabilities of the market and institutional arrangements, the central bank can play a large role in galvanizing such effects through lender of last resort leverage. It could also work with the Treasury to introduce modern technology into the government securities market, such as a ledger system that makes property account records secure and allows for simultaneous delivery versus payment through central bank deposit accounts. Monetary authorities must ensure that clearing institutions obtain the necessary credit lines from banks at the time of delivery and payment failures.

The interbank market is particularly important for monetary policy because it helps determine the appropriate timing and size of OOP. Many countries specifically tailor monetary policy instruments to the interbank market. The central bank, together with the treasury, should take the initiative to encourage market-based practices in the interbank market that promote competitive trading. This could be, for example, the introduction of computer systems for anonymous trading of securities. To promote market transparency, authorities should also discourage trading outside organized markets. The Treasury needs to take a special interest in competitive trading, given that the national debt burden is expected to decline over time as government securities become increasingly liquid.

FINAL OBSERVATIONS

Deregulation of financial markets makes administrative control over the banking system ineffective. International experience in this area shows that in the context of globalization, countries have no choice but to begin the transition to indirect regulation. Countries where the central bank delays the market transition subsequently face failure.

lamy in achieving monetary policy goals. On the other hand, as the crisis experience of Southeast Asia in the late 1990s shows, the use of market instruments does not at all guarantee the success of monetary policy. The presence of an arsenal of indirect instruments is a necessary, but not sufficient condition for the high efficiency of the actions of monetary authorities.

Most developing countries and countries with economies in transition have begun to use reserve requirements in conjunction with OOP. They also limited access to the discount window, which nevertheless remained open as a "safety valve" for the banking sector. At the same time, for most emerging markets and transition economies that are prone to liquidity crises and sudden capital outflows, combining all monetary policy instruments without relying on any one of them may be the optimal choice in terms of efficiency. Market transformation during the formation of OOP usually occurs in two stages: the organization of the primary market, and then the development of the secondary market.

It is difficult for the central bank to accelerate the development of the financial market through OOP alone, since it risks dominating the market and crowding out private borrowing with public borrowing. Peno and reverse peno trades are the most effective tools for encouraging early market development. At the same time, the central bank should actively promote the creation of a full-fledged interbank market, which will subsequently perform a signaling function for monetary policy. However, if a central bank relies excessively on private paper transactions, it is exposed to credit and liquidity risk. In the absence of a normal market for government securities, the use by the central bank of its own issues or special issues of the Treasury, strictly intended for monetary policy purposes, can be considered as an alternative option for intervention targets.

(Publication prepared based on materials from the International Monetary Fund)