Open market operation is the means of implementing monetary policy by which a central bank, such as Reserve Bank Of India (RBI) in India, controls the term interest rate and the supply of base money within the economy. Generally speaking, Open market operation is buying and selling of government securities by a central bank in the open market in order to control the money supply and credit conditions of the banking system. When the central bank buys securities on the open market, it actually facilitate growth in the economy as it increases the reserves of commercial banks making it possible for them to expand their loans and investments while sales of securities do the opposite. This buying and selling of securities helps in stabilizing the economy.
During an inflation, when too much of money in the market affects the value of a currency, sale of securities helps in taking out the money from the economy and stabilizing it. The targets used in implementation of open market operations include inflation, interest rates, exchange rates etc. The targets of these operations differ from one section to another. The most important goals of open market operations include attaining a specific short term interest rate in the debt markets, growth of the money supply, achieving and maintaining a fixed exchange rate etc.
Open-market operations are usually carried out with short-term government securities. As dealing in both short-term and long-term securities would distort the interest-rate structure and therefore the allocation of credit.