Open market operations is the sale and purchase of securities, bills and bonds of government as well as private financial institutions by the Central Bank. This is one of the qualitative too available with the central bank to deal with inflation and money supply in the economy.
Functioning: If the central bank sells these instruments, banks and public will buy it and pay moneyto the RBI.If the RBI buys these instruments from instrument holders, it will pay money to thelatter. The public who sold will deposit the money with the banks. So the resource ofbanks increase that helps to increase their lending capacity. When there is more moneysupply, the interest will come down. Therefore, more people will borrow from banks.The reverse is the case when RBI sells financial instruments.
During inflation the central bank sells government securities. As a result money supplyin the economy falls causing prices to fall. During deflation, the central bank will buy back the securities thus causing moneysupply to rise which cures deficiency in demand