Usefulness of Open Market Operation Policy of Central Bank in India!
1. As a complementary to the bank rate policy it tends to enhance the efficacy of the bank rate.
It may be used to prepare the ground for changes in the bank rate. When credit contraction is desired, the central bank may raise bank rates as well as sell securities in the open market, so that the cash reserves (credit base) of banks are also reduced. Conversely, when central bank may, at the same time, buy securities in the open market and, thus, provide additional cash to commercial banks to enable them to increase their advances.
2. It assist government borrowings. By purchasing government bills and bonds and such other securities when the prices are low and selling them when their prices are high, the central bank can maintain stability in the prices of government securities and thereby promote public confidence in the instruments of public debt.
3. It may be useful in contracting extreme trends in business by buying securities during periods of slack business and selling them in period of inflationary boom.
4. It may be adopted to influence the balance of payments position favourably. Open market sales operations, for instance, will have a contractionary effect on credit and a deflationary situation will develop so that the domestic price level will fall. Exports will be encouraged due to increased foreign demand on account of lower prices, whereas, imports will be restricted due to high costs of foreign goods. Thus, a favourable balance of payments will follow.
On these accounts, open market operations have come to be recognised as an important technique of monetary management. The growing importance of open market operations is due to the decline of bank rate as an instrument of credit control after the first war and the consequent need for another and more direct method. In the thirties, open market operations became necessary in order to implement the policy of cheap money.