Open Market Operation (OMO ) is conducted by Reserve Bank of India by way of sale or purchase of Government Securities/Bonds to increase or decrease money supply in the economy.
When the RBI feels there is excess liquidity (money supply) in the market and is interested in controlling inflation, it sells government securities to commercial banks .Banks pay the RBI in return of the Govt. Securities and this reduces excess reserves which in turn reduces the banks' ability to lend money, thereby decreasing money supply(sucking out the rupee liquidity) and increasing interest rates.Similarly, when the liquidity conditions are tight (means money supply is low), the RBI will purchase Government securities from the commercial banks, higher excess reserves means commercial banks can lend more money leading to increase in money supply and decrease in interest rates.
When the RBI feels there is excess liquidity (money supply) in the market and is interested in controlling inflation, it sells government securities to commercial banks .Banks pay the RBI in return of the Govt. Securities and this reduces excess reserves which in turn reduces the banks' ability to lend money, thereby decreasing money supply(sucking out the rupee liquidity) and increasing interest rates.Similarly, when the liquidity conditions are tight (means money supply is low), the RBI will purchase Government securities from the commercial banks, higher excess reserves means commercial banks can lend more money leading to increase in money supply and decrease in interest rates.
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