Permanent Open Market Operations (POMO)

What Are Permanent Open Market Operations (POMO)?

Permanent open market operations (POMO) refers to the U.S. Federal Reserve program of ongoing, unlimited purchases and sales of short term U.S. Treasury securities in the open market for Treasuries as a tool to help achieve its normal monetary policy targets. Open market operations (OMO) are the outright purchases or sales of securities for the system open market account (SOMA), which is the Federal Reserve's portfolio. Permanent operations can be contrasted to temporary operations where specific quantities of Treasuries are authorized to be purchased and held for a period to address a financial crisis or other economic emergency. When any central bank consistently uses the open market to buy and sell securities in order to adjust the money supply, it can similarly be said to engage in permanent open market operations. This has been one of the tools used by the Federal Reserve to actively influence the American economy for decades.

Understanding Permanent Open Market Operations

According to the Federal Reserve, open market operations (OMOs) are the purchases and sale of securities in the marketplace by a central bank. A central bank can give or take liquidity to other banks or groups of banks by buying or selling government bonds. The central bank may also use a secure lending system with a commercial bank. The normal objective of OMOs in recent years is to manipulate supply of base money in an economy in order to achieve some target short-term interest rate and the supply of base money in an economy.

When the Federal Reserve buys or sells securities outright, it can permanently add to or drain the reserves available to the U.S. banking system. Permanent open market operations (POMOs) are the opposite of temporary open market operations, which are used to add or drain reserves available to the banking system on a temporary basis, thereby influencing the federal funds rate.

How Open Market Operations Work

OMOs are one of the three tools used by the Federal Reserve for implementing monetary policy. The other two Fed tools are the discount rate and reserve requirements. Open market operations are conducted by the Federal Open Market Committee (FOMO), while the discount rate and reserve requirements are set by the Federal Reserve's Board of Governors. 

OMOs significantly influence the amount of credit available in the banking system. When the Federal Reserve buys securities from banks, it adds liquidity to the banking system by purchasing the securities with newly created bank reserves. The proceeds from the sale of these securities can be used by banks for lending purposes, and the additional liquidity allows banks to lend to each other more easily. This pushes short-term interest rates lower, with the goal of stimulating economic activity by making it cheaper for businesses and consumers to borrow and spend money.

Conversely, when the Federal Reserve sells securities to banks, it drains liquidity from the banking system, pushing interest rates higher. Banks have fewer funds to lend, which can act as a brake on economic activity. 

The Origin of Permanent Open Market Operations

Originally the Fed avoided handling Treasury securities, and instead preferred to trade in real bills such as commercial paper on a temporary, as-needed basis to address liquidity and funding shortages among member banks and industrial concerns. Through the early decades of its operation, the Fed episodically entered the Treasury market to help support the market for Treasury debt during World War I and the relatively mild recessions of the 1920’s. 

However it’s primary monetary policy tool remained the practice of discount lending to distressed borrowers in a manner that was hoped would semi-automatically stabilize the economy. Large scale, ongoing purchases of securities, and especially Treasury securities, were initially viewed as suspect and potentially dangerous for the economy. 

With the Great Depression, and later the funding needs of the war economy during World War II, open market operations became larger and more frequent. The Federal Open Market Committee was formed by law in 1933, and repeated and eventually ongoing, continuous, purchases of Treasury securities transitioned from a non-standard monetary policy to being the normal, day-to-day practice of monetary policy over the ensuing years. Significantly, the move to permanent open market operations marked a shift away from the Fed’s original purpose as a lender-of-last-resort and passive safety-net for the financial sector toward an activist Fed that continuously manipulates market liquidity and interest rates on an ongoing basis in an attempt to steer or even fine-tune the economy. 

Temporary Open Market Operations

The Federal Open Market Committee (FOMC) may occasionally have a different operating goal for its open market operations. For instance, in 2009, it announced a longer-dated Treasury purchase program as part of its open market operations. This program aimed to help improve conditions in private credit markets after an unprecedented credit crunch gripped global financial markets in 2008 and 2009. It did so by putting downward pressure on longer-term interest rates.