Open Market Operation mean sell and purchase of securities by central bank in open Market. The central bank of the country control the supply of money through open Market Operation. If supply of money needed to be reduced the central bank start the start purchasing securities from the market and if the supply is needed to be increased, it start selling securities in the open market. In this way reserve ratio with the central bank is adjusted and accordingly money supply is regulated in the economy.
Open market Operations are powerful weapons of control because their effect on volume of credit is several times larger than the amount of securities purchased and sold.
But there are certain limitations on the efficiency of open market Operation.
1. Open market operations are effective only if the cash reserve ratio of the commercial banks are fairly rigid. A fall in cash reserves will not lead to contraction of credit if the banks decide to keep a smaller quantity of cash as reserve.
2. Sale of securities to the public will not effect bank reserves if the people simultaneously dishoard money. Similarly, purchase of securities will not have any effect if liquidity preference increase and people start holding more money in the form of cash.
3. Open market operations can contract credit easily but expansion of credit is more difficult.
4.The extent of sale operations by the by the central bank depends on the amount of securities in its hands and willingness of the people to buy them.