Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Federal Open Market Committee (FOMC)

What it is:

The Federal Open Market Committee (FOMC) is main policy-making body of the Federal Reserve. The FOMC is responsible for conducting open market operations.

An open market operation is the buying or selling of U.S. Treasury bills and bonds in the open market. The transactions take place between the Fed and banks, not the Fed and the U.S. government. 

How it works (Example):

The FOMC's purchase or sale of Treasuries affects the money supply through a chain reaction.

For example, consider an FOMC effort to reduce the federal funds rate. The FOMC indicates to banks that it wants to purchase U.S. Treasuries. When the Federal Reserve buys the Treasuries, it pays the banks in dollars.

The banks now have extra dollars to lend out to customers. Because the supply of dollars is now higher, the banks entice customers to borrow by lowering interest rates.

If the FOMC needs to increase the federal funds rate, it indicates that it will sell U.S. Treasuries. The banks exchange their dollars for Treasuries, and the supply of dollars in the banking system decreases. Because the supply of dollars is lower, the cost of money (the interest rate) goes up.

Why it Matters:

The FOMC usually meets eight times per year with the goal of setting the federal funds rate. Because the size of the money supply affects interest rates and therefore the valuation of all assets (stocks, bonds, houses, etc.), the anticipated actions of the FOMC are the subject of considerable speculation. The outcomes of meetings can lead to dramatic price changes in the financial markets.