Appendix E: How Open Market Operations Affect Balance Sheets
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Appendix E

How Open Market Operations Affect Balance Sheets

Pages 923–924 · Back Matter
Open market operations are easier to understand when tracked as explicit asset-liability changes across the Fed and banking system.

As we noted in our discussion of open market operations, in a limited reserves environment the FOMC can affect banks' balance sheets and the money supply. The following figures shows this process in detail.

Changes in Happy Bank's Balance Sheet

The figure shows 3 t-accounts. T-account (a) has the following assets: reserves = 40; bonds = 120; loans = 300. T-account (a) has the following Liabilities: deposits = 400; net worth = 60. T-account (b) has the following assets: reserves = (40 + 20 = 60); bonds = (120 – 20 = 100); loans = 300. T-account (b) has the following liabilities: deposits = 400; net worth = 60. T-account (c) has the following assets: reserves = (60 – 20 = 40); bonds = 100; loans = (300 + 20 = 320). T-account (c) has the following liabilities: deposits = 400; net worth = 60.

CNX_Econ3e_C28_014 (a) shows that Happy Bank starts with $460 million in assets, divided among reserves, bonds and loans, and $400 million in liabilities in the form of deposits, with a net worth of $60 million. When the central bank purchases $20 million in bonds from Happy Bank, the bond holdings of Happy Bank fall by $20 million and the bank’s reserves rise by $20 million, as CNX_Econ3e_C28_014 (b) shows. However, Happy Bank only wants to hold $40 million in reserves (the quantity of reserves with which it started in Figure 15.5) (a), so the bank decides to loan out the extra $20 million in reserves and its loans rise by $20 million, as CNX_Econ3e_C28_014 (c) shows.

The figure shows 3 t-accounts. T-account (a) has the following assets: reserves = 40; bonds = 120; loans = 300. T-account (a) has the following Liabilities: deposits = 400; net worth = 60. T-account (b) has the following assets: reserves = (40 – 30 = 10); bonds = (120 + 30 = 150); loans = 300. T-account (b) has the following liabilities: deposits = 400; net worth = 60. T-account (c) has the following assets: reserves = (10 + 30 = 40); bonds = 150; loans = (300 – 30 = 270). T-account (c) has the following liabilities: deposits = 400; net worth = 60.

CNX_Econ3e_C28_015 (a) shows the balance sheet of Happy Bank before the central bank sells bonds in the open market. When Happy Bank purchases $30 million in bonds, Happy Bank sends $30 million of its reserves to the central bank, but now holds an additional $30 million in bonds, as CNX_Econ3e_C28_015 (b) shows. However, Happy Bank wants to hold $40 million in reserves, as in CNX_Econ3e_C28_015 (a), so it will adjust down the quantity of its loans by $30 million, to bring its reserves back to the desired level, as CNX_Econ3e_C28_015 (c) shows.

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