Operation_Twist

Operation Twist In 1961, John F. Kennedy was placed into office at a time when the economy was formally in a recession. As a new president his first order of business was to get the economy back in full capacity, thus he had announced a joint monetary venture with the Fed to stimulate the economy and fight unemployment which was then at 6.8% . The monetary policy proposed was known to the Fed as Operation nudge, name for the effect of nudging interest rates by altering positions in the feds portfolio. However, Wall Street renamed the program Operation Twist, after the chart topping song “the twist” by Chubby checker in the 1960. Operation nudge, now dubbed Operation Twist was named largely due to the twist in interest rates. The policy forces long term rates down, and moves short-term rates higher. In this time period the world was still on the gold standard so a raise in the short term rates would also strengthen the dollar, and lowering of long term rates would strengthen the economy. In today’s economy the execution of operation twist is slightly different. In 2008 the Fed announced that it would hold short-term interest rates near zero until mid 2013 because of the financial crisis. The fed needed to find ways to stimulate the fragile economy, so they bought mortgage backed securities and long-term treasury bonds. In 2010 the economy continued to suffer and the ST interest rates were still at 0%, so the Fed announced QE2 a plan to buy $600 billion of long-term treasury securities to stimulate the economy. In QE1 and QE2 the Fed basically infused the Economy with money, instead this time the Fed used the same tactic as JFK did in the 1960s. The fed shifted its portfolio holdings from short-term bonds to long term bonds. With the selling of short term bonds, the prices should drop and the interest raise rise, but since the Fed promised 0% interest rates until 2013 the short term interest rates needed to stay at or near zero. The effect on long term bonds is the same as in 1960; the buying of large quantities of long-term bonds raises the price and lowers the interest rates. This policy effectively silences the controversial efforts of QE2 program, because the detractors conjectured that the policy risks currency debasement and inflation, and this policy avoids expanding the Fed’s balance sheet. The idea was that business investment and housing demand were primarily determined by longer-term interest rate and that with the decrease in long term interest rates, more people will be willing to buy housing. There are two problems, one that banks primarily borrow on short-term loan and lend on long term loans, by reducing rates they will make less money on the long term loans, thus lowering margins. Also, even if the long term loans are lowered slightly, there is still no demand for housing, as shown by the interactive graph(graph2) .Consumer demand is still lower than pre-recession levels, people are not willing to borrow money and buy housing because they still do not have confidence in the economy. Interest rates are already at the lowest level in a long time, perspective home buyers are not putting off buying housing because rates are too high, so a small decrease in long term interest rates will not affect their decisions. Consumers are worried about unemployment, double dipping into a recession, and are unwilling to take the risk of more debt. In my opinion “The duration of the Fed’s portfolio is not what stands between us and Economic Prosperity”.