On the Relevance of Open Market Operations1

This paper reexamines the role of open market operations for short-run e¤ects of monetary policy in a New Keynesian frame-work. The central bank supplies money in exchange for securities that are discounted with the short-run nominal interest rate, while money demand is induced by a liquidity constraint. We allow for a legal restriction by which only government bonds are eligible. Their supply is bounded by \u85scal policy that is assumed to be Ricardian. If public debt is dominated in rate of return by private debt, open market operations matter, and an endogenous liquidity premium and a liquidity e¤ect arise. Nominal interest rate setting (including a peg) is then associated with price level and equilib-rium uniqueness, regardless whether prices are exible or set in a staggered way. Thus, the legal restriction overcomes indetermina-cies due to an unbounded money supply, as implied by the real bills doctrine. Moreover, it facilitates constant money growth and interest rate policy to be equivalent. JEL classi\u85cation: E52, E32