Question

Distinguish between dynamic and defensive open market operations. What is the purpose of each type? How are defensive open market operations typically conducted?

Answer 1

Dynamic open market operations are those in which the Fed is deliberately trying to change the pace of fed-eral funds to a new target (which was agreed at the FOMC meeting). To order to keep the federal funds rate as close as possible to the target, protective open market operations are daily trading practices. Such trading practices merely seek to counteract the "unwanted" swings in the economy.

The Federal Reserve carries out open market operations aimed at regulating short-term interest rates and money supply. Such operations are classified into two categories: dynamic open market operations are intended to change reserve rates and monetary base, and defensive open market operations are intended to counter fluctuations in other factors affecting reserves and monetary base, such as changes in Fed Treasury deposits or changes in floats.

Strategies used in open market operations to mitigate certain expected market conditions likely to affect the volume of the economy's funds. For example, if a foreign country is expected to sell its US treasury securities in return for US dollars, the Federal Reserve will decide to purchase treasury securities in advance so as to maintain the same level of US dollars.