People frequently refer to the open-market operations of the Federal Reserve Bank as if all participants were the same. That definitely is not true. The Fed deals with different entities in what they refer to as open-market operations, but there are some important distinctions.
I will briefly outline the major distinctions between the different types of buyers and sellers with which the Federal Reserve deals. Although these transactions become much more sophisticated or complicated than what I describe, these are the important distinctions.
The term open market operations, which the Federal Reserve Bank uses, refers to a market that’s not as open as that term would imply. The Fed does not purchase securities directly from the US treasury or private citizens. The Fed purchases and sells securities only through what are known as primary dealers.
I have provided a link to the list of primary dealers at the bottom of this blog post. I chose not to reproduce that list here because the names change periodically.
When the Fed purchases securities, it always pays by adding reserve-dollars to its liabilities for the seller’s benefit. The type of seller, however, makes a big difference in the effect on the money supply.
For this article, I wanted to explain the difference between the two major types of primary dealers: banks and nonbanks.
When a bank sells securities from its own account, it receives a credit in its reserve account for the amount of the sale. That transaction alone does not affect the quantity of money (or money-dollars.) The bank has no obligation to create new money-dollars.
When a non-bank sells securities to the Federal Reserve, the Fed credits the reserve account of the bank at which the non-bank seller has an account. In this case, the bank receiving credit in its reserve account has an obligation to create new money-dollars for the account of the non-bank seller.
The Federal Reserve’s transactions in its open-market operations can frequently be highly complicated. The main thing to remember is that the type of seller determines the immediate effect of Federal Reserve securities purchases in the “open market.”
Don’t fall for expressions like “the Fed is pumping money into the economy.” In simple terms, the Fed does not have the power to force money into the economy. It is, however, a big player in the market for US government securities. To know whether their transactions affect the money supply, you must also know the nature of the seller.
In addition, to understand what happens when the Federal Reserve sells securities, the effect of the type of buyer is reversed.
List of Primary Dealers