Will the Federal Reserve’s

21st June 2012

The program which was set to expire at the end of the month, but now extended until the end of the year, means that the Fed will sell $267 billion  in shorter-term securities and replace them with longer-term bonds.

So what is ‘Operation Twist'? Here's a Q&A on the Fed program from Bloomberg Businessweek:

Where does the name come from?

The Fed took similar steps in 1961, soon after the inauguration of President John F. Kennedy. It first called the program Operation Nudge, because it was intended to nudge long-term interest rates lower. But at the time, Chubby Checker's record "The Twist" was popular, hitting the No. 1 spot in late 1960, and the name "Operation Twist" stuck instead.

How does the program work?

The Fed sells Treasury securities it owns that mature in less than three years and buys longer-term bonds that mature in six to 30 years. The Fed will also reinvest the proceeds from its mortgage-backed securities that mature into new ones.

What's the goal?

By buying longer-term Treasurys, the Fed intends to lower longer-term rates and encourage more borrowing and spending. Lower rates could also lead more investors to shift money into stocks because they'll receive less return on their investment in Treasury bonds.

When did Operation Twist start?

In September. That's when the Fed said it would sell $400 billion of its shorter-term securities to buy longer-term holdings to try to lower Treasury yields.

Has it worked?

It's impossible to know for sure. Many economists think Operation Twist has helped keep rates on mortgages and other consumer and business loans near record lows. But given how low rates already are, few think the extension of Operation Twist will lead to much more borrowing.

In his analysis of the move, the BBC's North America editor Mark Mardell said the Fed was largely reacting to its somewhat bleak evaluation of the condition of the US economy. It says the recovery is still underway, but it has slowed down, and what's going on in the rest of the world, especially in Europe, poses "significant risks."

"So it's acting to keep long-term interest rates low, which it hopes will encourage people to spend and businesses to take on more workers. It's the extension of a policy that began last September and the jury is out on whether it has worked so far."

"In the current political environment the Fed is the only actor with a role. Even if there wasn't a presidential election looming, Congress would still be deadlocked and neither Democratic nor Republican plans stand a chance of being turned into reality. The Fed could print more money (or the modern equivalent) but that would be hugely politically controversial. The bottom line is it's not doing much, but it's the only one doing anything to prop up a faltering recovery."

Meanwhile, in its Review & Outlook section, The Wall Street Journal says (rather sarcastically) that the extension of ‘Operation Twist' is just what the economy needs: "Another temporary stimulus that may or may not end when the powers in Washington claim it will." Referring, of course, to the extension of the Bush tax cuts and unemployment benefits – which are all set to expire at year's end – leading to what analysts are now calling the ‘fiscal cliff' (or was it ‘Taxmageddon.')

The piece concludes by saying that the very uncertainty of monetary policy is becoming a problem, as investors hang on every word Ben Bernanke and other Fed officials say and play the Treasury market, rather than wielding their animal spirits. "Markets can now spend the next two months speculating about whether the Fed will use its August meeting to commit another round of bond purchases that will be called QEIII."

"The basic mistake is relying on monetary policy to conjure growth, when what we need are supply-side fiscal and regulatory policies."

More on Mindful Money:

Is Greece the word? Or should Germany leave the euro?

Is Spain a 'submerging' market

Eurozone: The political cost of a Greek exit

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The Financialist

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