<P> An open market operation (OMO) is an activity by a central bank to give (or take) liquidity in its currency to (or from) a bank or a group of banks . The central bank can either buy or sell government bonds in the open market (this is where the name was historically derived from) or, in what is now mostly the preferred solution, enter into a repo or secured lending transaction with a commercial bank: the central bank gives the money as a deposit for a defined period and synchronously takes an eligible asset as collateral . A central bank uses OMO as the primary means of implementing monetary policy . The usual aim of open market operations is--aside from supplying commercial banks with liquidity and sometimes taking surplus liquidity from commercial banks--to manipulate the short - term interest rate and the supply of base money in an economy, and thus indirectly control the total money supply, in effect expanding money or contracting the money supply . This involves meeting the demand of base money at the target interest rate by buying and selling government securities, or other financial instruments . Monetary targets, such as inflation, interest rates, or exchange rates, are used to guide this implementation . </P> <P> The central bank maintains loro accounts for a group of commercial banks, the so - called direct payment banks . A balance on such a loro account (it is a nostro account in the view of the commercial bank) represents central bank money in the regarded currency . Since central bank money currently exists mainly in the form of electronic records (electronic money) rather than in the form of paper or coins (physical money), open market operations can be conducted by simply increasing or decreasing (crediting or debiting) the amount of electronic money that a bank has in its reserve account at the central bank . This does not require the creation of new physical currency, unless a direct payment bank demands to exchange a part of its electronic money against banknotes or coins . </P>

How does central bank use open market operations to control money supply
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