Strategic Briefing | 9.22.2011 | The Fed’s “Operation Twist”

Twist and Yawn
David Beckworth (Macro and Other Market Musings) | Sep 21
The Fed decided today it would lower the average maturity of publicly-held treasuries by selling $400 billion of shorter-term treasuries and buying the same amount of longer-term treasuries. In addition, the Fed also reconfirmed its commitment to maintain the size of its mortgage holdings and anticipated its targeted interest rate would remain low through mid-2013. The burning question now is how big of an impact will the Fed’s new treasury maturity transformation or “operation twist” program have on the economy? Not much in my view. It should add some monetary stimulus, but like the original operation twist its effects will probably be modest and do little to spark a robust recovery… Without an explicit target to permanently shape expectations about future spending and inflation, it is hard to see how this new stimulus program will have any more lasting power than QE2. The Fed needs to quit throwing large dollar programs at the economy and instead commit to buying up as many assets as needed until some nominal GDP (or price) level target is hit.

It’s What They Didn’t Say
Scott Sumner (The Money Illusion) | Sep 21
I’m on record that the Fed’s goal should be much higher long term interest rates (achieved through monetary stimulus.) The econ textbooks rarely even discussed the original operation twist (from the 1960s), except occasionally to note that it probably had no effect. There’s a reason it was tried and then abandoned. So I thought it worse than nothing—something that diverted the Fed’s attention, and made effective moves less likely…
This looks more and more like the Hoover Administration. Initially his initiatives were greeted with big stock rallies. But by mid-1932 the stock market reacted to his speeches with big declines. Not because we were “out of ammunition;” the minute FDR got in things turned around. Well that’s not quite right, the stock market did nothing until the April 1933 dollar devaluation, when it began rocketing upward. Symbolism isn’t enough, you need level targeting. Ben Bernanke understood this when he recommended the Japanese show “Rooseveltian resolve.” What happened to that Bernanke?
FOMC Reaction – The Extended Version
Tim Duy’s Fed Watch | Sep 21
I think Fed official believe they are being bold; I see them as continuing to ease policy in 25bp increments. Expect that to continue. Assuming the economy fails to regain momentum, the Fed will follow up with additional action – QE3 will be the next stop. Ignore the dissents; they are background noise. Don’t expect miracles; expect small moves, the equivalent of 15bp here, 25bp there. The real leverage could potentially come from fiscal policy leveraging the easy monetary policy. Print the money and spend it. Open up the refinancing channel. Overall, make the objective of national economic policy simply be to decisively move us off the zero bound. Not deficits, not the dual mandate, just commit to pulling us off the bottom.
FOMC Decides to Implement Operation Twist
Mark Thoma (Economist’s View) | Sep 21
This shifts the duration of the balance sheet, but it does not change its size. I would have preferred balance sheet expansion, i.e. QE3, as that would have a much better chance of helping the economy. But the inflation hawks on the committee will not tolerate further expansion in the balance sheet due to worries about inflation.
Operation Twist–Conditional Support
Bill Woolsey (Monetary Freedom) | Sep 21
By having the Fed sell off its holdings of short term government bonds, the Fed will relieve that underlying excess demand for those securities and lessen any shift of that excess demand to an excess demand for money. It should help relieve the monetary disequilibrium. Of course, if the Fed reduced the quantity of base money, as would be the usual consequence of an open market sale, then any decrease in money demand would be offset by a decrease in the quantity of money. However, by purchasing long term bonds, the Fed sterilizes the impact of the sale of short term bonds on the quantity of base money.
The other way to look at the issue is that with nominal interest rates on T-bills (nearly) at zero, they are perfect substitutes for money. By selling T-bills and purchasing long term government bonds so that base money does not decrease, the total quantity of money, T-bills held by households and firms and base money, increases. This will tend to relieve the excess demand for money.
“Operation Twist” Gets Underway
Jay Bryson (Wells Fargo) | Sep 21
In our view, however, the problem is not that long-term interest rates, especially mortgage rates, are too high. Indeed, the interest rate on the 30-year fixed rate mortgage is only about 4 percent at present, the lowest rate in decades. Rather, the problem is that credit remains very tight and many homeowners are “underwater,” preventing them from refinancing at very attractive rates. Despite historically low rates, mortgage applications for purchase remain depressed (Figure 2). Applications for refinancing have ticked up in recent weeks, but much less than what would be expected given today’s historically low rates.
Therefore, we do not believe that “Operation Twist” will be the silver bullet that is needed to solve all the economy’s problems. We do not mean to criticize the Fed for its actions today. The Fed long ago ran out of conventional “ammunition.” That is, the FOMC cut the fed funds rate to essentially zero percent in December 2008, the level where the fed funds rate remains today. If the Fed could cut its main policy rate even further, it clearly would. However, the lower bound of zero percent is preventing the Fed from undertaking further conventional stimulus. The Fed is in uncharted territory at present, and it is doing all it can to help the struggling economy get back on its feet via unconventional policy actions.
Could the Fed do more? Arguably, the FOMC could authorize another round of quantitative easing (QE). However, the efficacy of further QE is unknown, and the policy is seen as controversial, certainly outside of the Fed and arguably within the Fed as well. As they did at the last policy meeting, at which the FOMC said that it would keep the fed funds rate at “exceptionally low levels…at least through mid-2013,” three FOMC members voted against today’s decision because “they did not support additional policy accommodation at this time.” QE3 could eventually occur. However, we think that the bar for further QE is relatively high. Only if inflation recedes significantly over the next few months and/or the economy appears to be rolling back into recession do we think that a critical mass of Fed policymakers will support another round of QE.