Due to the sluggish economic recovery, the Federal Reserve launched Operation Twist. This is the latest effort by America’s central bank to turn things around using monetary policy. Many hope the project will lower long-term interest rates, including mortgage rates. If history is any indication, however, shuffling around government bonds won’t have much affect.
What Is Operation Twist?
For the last couple years, the Federal Reserve has engaged in qualitative easing by buying up treasury bonds about to expire. Operation Twist has the Fed trading in short-term government bonds for medium-term bonds and long-term bonds.
The program attempts to raise the price and lower the yield on these medium- and long-term bonds by limiting supply and driving up demand. Yield and interest rates are directly related. The Fed hops this will lead to lower interest rates across the board.
The Plan: Decrease Long-Term Interest Rates
The Fed currently owns $1 trillion in government bonds, bought during the recession to decrease medium- and long-term interest rates. Medium-term bonds will be sold and long-term government bonds bought with the proceeds.
Ten-year treasury bonds are an excellent example of what the Fed is looking to buy in their attempt to bring down interest rates.
Operation Twist and Mortgage Rates
While Operation Twist seeks to stabilize the economy through further lowering interest rates, some have predicted mortgage rates will hit an all-time low. This isn’t the first time the Fed has attempted to alter interest rates through changing its bond portfolio.
In 1961 the Fed lowered long-term interest rates through similar government bond portfolio changes by a whopping .15 percent. For his own part, Fed chief Ben Bernanke wrote a paper in 2004 discouraging the strategy as a successful weapon against high long-term interest rates.
What Operation Twist Doesn’t Do
Operation Twist merely changes the specifics of Federal Reserve investment in government bonds.
Swapping out short- and medium-term bonds for long-term bonds won’t probably have a massive effect, due to the limited nature of the program. Whether or not long-term interests rates will drop is anyone’s guess. The program does not, however, open up the economy by pumping more money into it.
Monetarists, Keynesians, Conservatives and Government Bonds
The Operation Twist plan is not without critics. While Bernanke championed the plan as a way to lower long-term interest rates and mortgage rates, several Republican Congressional leaders urged the Fed to stay out of the economic recovery. Three regional presidents offered dissent in August and reiterated opposition as the Fed began Operation Twist.
The implementation of Operation Twist shows the dominance of monetarists–those who favor using monetary policy to fix the economy–over Keynesians, who favor infrastructure projects and efforts aimed at raising consumer confidence.
Conservatives in Congress oppose both forms of intervention, preferring to allow the business cycle and the market correct themselves.
Potential Problems
The plan doesn’t just have neutral potential–it could actually make things worse. No one is not buying things because interest rates are too high. On the contrary, as we’re currently seeing the lowest mortgage rates in 60 years. Some financial experts have expressed concerns that, if Operation Twist goes wrong, it will by the spark next to the powder keg of the next Great Depression.
The short answer, however, is that no one is certain. Only time will tell if Operation Twist is just what the doctor ordered, a non-starter or a disaster.
Read More: Operation Twist References
