Open market operations
In a market economy the price level should decide (though, as the name says) market. Is, therefore, the central bank has the right to interfere in the market and the process of changes in interest rates? Yes, the central bank has such a right because he emits money and can decide the price of the good it provides. Although alternative forms of money (eg. Bitcoin) are gaining popularity, it is a predominance of money emitted by the central bank is its widespread acceptance.
The central bank is focused on the reference rate. Banks lend money to each other for different periods of time depending on the needs of the borrower and the lender possibilities. Money Market Loans provides both for a few hours (so-called operation overnight (O / N), i.e. overnight), and for many months (eg. 52 weeks). Loans for 12 months are the border before crossing where we are in the money market, and after crossing enter the precinct of the capital market and its extremely important segment, which is the bond market. Here we can look borrowed money with the time horizon of up to 100 years.
The central bank is particularly urgent loans with the shortest period of flammability, or O / N. Banks can lend money to each other after such a rate, at which the parties participating in the transaction agree. In this case very useful is called. the rate of sonorous name of Polonia. What is the rate?
Logic would prompt that it is the average of all transactions in the money market O / N. Yes, but it is a weighted average. And the thing is that one of the most important tasks of the central bank is to POLONIA rate was as close as the level of which is determined by the reference rate.
Now consider why market interest rates does not automatically follow the rates set by the central bank? Well, in the banking system may occur or the phenomenon of liquidity shortage or an excess of liquidity. As the banking system consisting of identified with big money banks can demonstrate a shortage of liquidity? One reason may be difficult to collect advance loans. Do not receive on time before someone borrowed money very badly affects just on the bank's liquidity. Bows here the famous terminated by J. M. Keynes' maxim: How to borrow someone 5000 that you have it in your pocket. But how do you borrow someone for example. Fifty thousand, rather he already has us in his pocket. Similarly, the banks. The phenomenon of excess liquidity occurs when the banks have too much money and do not want them to lend to other banks or their customers (for this option, even for a moment).
The shortage of liquidity makes the market rates are moving in the direction of the lombard rate. On the other hand, excess liquidity makes the market rates is closer to the deposit rate than the reference rate. A central bank is the guardian of the POLONIA rate has sought to reference rate. Let's face it, that state of equilibrium in the banking system is de facto purely theoretical, and in the banking system there is either the liquidity deficit or a surplus. In other words, there is always a centrifugal force that moves our rate POLONIA reference rate. The response from the central bank on the above-mentioned centrifugal force are known. open market operations.
The first step is to determine the size of the liquidity deficit or surplus of liquidity (which we still talk). Older readers will remember the old-fashioned mechanical scales that can be seen frequently or at markets or in the so-called. warzywniakach popular. Description of the functioning of such importance will help us to understand the essence of open market operations. Both the seller in the marketplace and his client had agreed to say a transaction of purchase / sale of 2 kg of potatoes for the price of $ 5. It is easy to calculate that the price of 1 kg of potato is 2.5 zl. Seller on one side of the scale put weights (sum of which was 2kg), and on the other side dosypywal a bucket potatoes until the two sides of the weight is not leveled with each other.
Market Operations resemble a kind of the above-described weight, where on one side we have a surplus / deficit liquidity (where potatoes of the above-cited example), and on the other hand, bills or other debt securities (which resemble the weights of the above-mentioned example). It is because of these debt securities (ie, our weights) bank regulates the liquidity in the banking system in such a way that the POLONIA rate was as close as the reference rate. If we are dealing with excess liquidity, the central bak does weights (emits debt), and the deficit as a bank takes off from the balance weights (usually buys securities).
When is already known range of imbalances, the bank goes to a specific action, namely the conduct of open market operations. They can be unconditional and conditional. The former come down to buy / sell securities. Conditional operations may seem at first glance more complicated. The central bank buys / sells commercial banks of debt securities (usually these are treasury securities) of a specific date resale operations (that is, de facto their return). Most often this term resale is a period of seven days. In the case of buy (and sell) we are dealing with the operation repo (ang. Repurchase agreement - conditional operation of purchase), and in the case of sale (and subsequent redemption) reverse repos (reverse repos). This may sound rather complicated, but really it's all about the so-called. secured loan between a commercial bank and the central bank. The latter makes a loan, but in return receives these debt securities, which are treated here as a kind of deposit. It guarantees that the bank would give the money after seven days. To find out more about these operations, there is a wealth of literature in this field. You must be careful, however, to use the concept of the word repo. It can also refer to one of the segments of the money market segment that is secured transactions and not having too much in common with the discussed here open market operations.
And why such an operation from the central bank is to serve? Now, in the conditions of deficiency (excess) liquidity of those banks that can still lend to do it at a higher (lower) rate of the reference rate. In other words, the POLONIA rate goes above (below) the reference rate (1.5%) and the effect of such a system in need of money banks have to pay higher (lower) interest rate. Repo operations with the central bank aims to bring rates closer to 1.5%. This is because it offers de facto its reference rate on the loan, or 1.5%. Thus, other banks are ready to enter into transactions at an interest rate significantly different from the reference rate (1.5%), seeing the competition in the form of loans from the National Bank of USA, they decide to bring the amount of its interest rate to the level desired by the central bank.
This raises the question however, and what will happen after seven days, that the expiry date initiated transactions? Now, after the finalization of the banks with the central bank operations can immediately enter into the next. Therefore discussed here operations take place in a cyclical manner within the prescribed date in advance (this is usually the last working day of the week). Cyclical nature of open market operations generate predictability and as a result of the elimination of fear about cutting off funding sources. Of course, the central bank contact with the market is not limited to take place on a weekly open market operations. After all, it can happen something urgent and demanding intervention from the central bank in the middle of the week. Then we deal with fine-tuning operations, while the central bank's response to the problems of a structural nature (requiring action spread over time) are, as the name says, the structural operations. Both logic and the way to carry out fine-tuning operations and structural, is very similar (which does not mean identical) to those described here open market operations.
Open market operations and the economy and our daily needs
Banking system for a long time but struggling with excess liquidity. In this arrangement, the central bank normally would carry out reverse repo operations (after called. Reverse repos). NBP, in turn, decides to issue its own debt securities, through which pulls excess liquidity, which is the reason for the decline rate of Polonia below the reference rate. This is due to an excessive amount of money, which, as has already been explained, generates a decrease in its price (or interest rate).
It would seem that the described operations are something of automatism. Unfortunately, this is only an illusion. We live in very uncertain times. Despite the enormous progress in the last quarter, USA is still a country in the output. The same applies to our banks (yes, most of them already has a so-called. Foreign mother, but, paradoxically, it only complicates the last system). It is the foreign banks were experiencing great difficulty (some even collapsed). The bankruptcy of US investment bank Lehman Brothers caused a real earthquake, including its range of all financial markets in the world. USA was no exception. The fact is that USA bravely confronted the then-perturbations, but we have no guarantee that in the event of a similar shock resistance financial institutions will be as high as last time. One reason for the good evaluation of the banking system is its conservative (read very carefully) operation. Very high in the merit of the central bank, which does not exert very strong pressure on completely getting rid of the banks operating in excess liquidity. The thing is that it is treated as a kind of airbag.
This is thanks to the hard work NBP experts mentioned at the beginning of this text. They have a hint how to conduct open market operations in order to Polonia was as close as the reference rate without simultaneous inhibition of lending to banks and tear-off their air bag having amortize them against shocks from abroad.