Basically, the plan is for the Fed to sell 400 billion USD worth of their short-term securities and to start buying up long-term ones. This would effectively “twist” the yield curve, pushing down longer-term interest rates. In theory, this should stimulate borrowing (since rates are low), which should eventually lead to spending and growth down the line.
However, there are those within the Fed itself who question whether this will actually get the job done.
I present to you, the one, the only, the great Richard Fisher of the Federal Reserve Bank of Dallas!
According to Fisher, Operation Twist may lead to a substantial increase in the savings rate, which could prevent people from actually spending. He believes that savers may see the program as a stepping stone to further quantitative easing and in turn cut back on doling out some Benjamins.
Furthermore, Fisher is concerned about the potential impact on banks’ earnings and pension funds. Earnings would drop as the tightening of the spread between short-term and long-term rates would take a bite out of the bottom line profitability, while pension fund contributors may be asked to pay more in order to hit targets set in a better economic environment.
Why? Remember, interest rates and bond prices have an inverse relationship. So when the Fed raises rates to tighten monetary policy and prevent the economy from overheating, long-term assets prices would drop, hurting the Fed’s balance sheet.
On the other hand, Federal Reserve Bank of Atlanta President Dennis Lockhart believes that Operation Twist could have a modest impact on economic growth. Although he pointed out that the program won’t be able to remedy everything that’s going wrong in the U.S. economy, he said that Operation Twist could still help.
Aside from that, he also explained that the success of the program shouldn’t be evaluated all on its own but instead be taken in light of other accommodative policy measures. Besides, as most Operation Twist critics already mentioned, simply lowering longer-term interest rates won’t be enough to stoke growth. With that, Fed officials are probably still conjuring more ways to keep the U.S. economy on its feet.
However, monetary policy without the aid of fiscal policy is like pushing on a string, as Fisher put it. Pumping easy money into the economy is necessary to keep an economy afloat but it isn’t enough to ensure growth. The goals of monetary policy should also be in line with that of the government’s fiscal measures to make sure that the programs do not clash. For instance, lower borrowing costs that encourage spending shouldn’t be met with higher taxes on goods that discourage purchases. This would just eliminate the positive effects of lower borrowing costs.
For now, it seems that the odds are stacked against the success of Operation Twist. Interest rates are already at their record lows and pushing borrowing costs a tad lower probably won’t make much of a difference. After all, fears of a double-dip recession are still preventing businesses from investing and expanding. On top of that, consumers are afraid to spend and take advantage of cheaper loan rates because they are worried about their jobs. Let’s hope the Fed and the U.S. government have more tricks up their sleeves and work hand in hand to save the U.S. economy.