Essentially the Federal Reserve will purchase longer term securities (to try to move the long-term interest rate a little lower) that are financed from the sale of short-term securities. The securities they would be buying would most likely be Treasury bonds with 6 to 30 years remaining until maturity and selling Treasury bonds with maturities of 3 years or less. According to the statement from the Federal Reserve, the largest purchases will be in the 6-10 year range. Ben Bernanke hopes that by doing this it will encourage more people to either buy or refinance homes. Lower rates should ease the debt burden on households and stimulate more investment and spending by business and individuals. It will remain to be seen if this will do much to spur the economy as rates are already at historic lows, and until more people are employed and the standoffs in Washington are resolved, it is tough to see how this will do much to spur demand.
This is actually Operation Twist II. The first Operation Twist was done during President Kennedy’s tenure in the early 1960’s. The name was derived from the dance craze “The Twist” that was sweeping the nation at that time. The economy was weak and the idea was that business investment and housing demand were determined by longer term interest rates. Policymakers reasoned that if longer-term interest rates could be lowered without affecting short-term yields, the weak U.S. economy could be stimulated. (From the Federal Reserve Bank of San Francisco website). Did it work? No, as long term interest rates continued to rise. Bernanke even wrote a paper 7 years ago that said “Operation Twist” was a failure, so why is he trying it again? It appears that the Fed is about out of bullets.
The two primary problems facing the U.S. economy have been and remain high unemployment and a terrible housing market. QE1, QE2 and Operation Twist have done and will do nothing to solve these problems. The only results so far have been to push investors towards more risky investments, something we are unwilling to encourage. Prudent investors who like fixed income for stability are paying an unofficial tax (penalty) by having to accept lower interest rates. Wall Street with their higher risk tolerance (backed by government guarantees) has been a big winner.
The only way out of this mess is to create encouragement for small businesses to start hiring people here in the U.S. The easiest way to achieve this would be for the President and Congress to create a long term (more than 30 days) fiscal policy that makes common sense. We desperately need a coherent tax policy that removes come of the complexity, reduces rates, eliminates many deductions and results in higher and fairer revenue. This, together with rational spending reductions, would provide encouragement to business and start to solve the unemployment problem, leading in turn to solving the housing crisis. We need short term pain shared by everyone in order to set the stage for the long term prosperity this country is capable of achieving. Unfortunately, we do not see any political leaders willing to make the sacrifices necessary to set us on the right track.
