Federal Reserve's Operation Twist: Did It Work?
Operation Twist is a program of quantitative easing used by the Federal Reserve. The so-called "twist" in the operation occurs whenever the Fed uses the proceeds of its sales from short-term Treasury bills to buy long-term Treasury notes. Short-term instruments mature in three years or less while long-term notes and bonds have a term between six and 30 years. Normally, the central bank replaces its purchases of short-term bills with new short-term bills.
Operation Twist is designed to put downward pressure on longer-term interest rates. It does this by lowering long-term Treasury yields. By buying long-term notes with the proceeds from short-term bills, It increases demand for Treasury notes. As demand rises, so does the price, just like any other asset. But higher bond prices are offset by a lower yield for investors.
How does this lower interest rates? The 10-year Treasury note yield is the benchmark for interest rates on all fixed-rate loans. These include loans for homes, cars, and furniture. Lower fixed rates also allow businesses to expand more cheaply. The result is an expanding economy.
Federal Reserve Chairman Ben Bernanke announced the $400 billion Operation Twist program in September 2011. As Treasury short-term bills and notes matured, the Fed used the proceeds to buy longer-term Treasury notes and bonds. The Fed would also buy new mortgage-backed securities as the old ones became due. The Fed could also buy the long-term Treasurys with proceeds of MBS if it felt necessary.
The twist showed that Bernanke was shifting the central bank's focus from repairing the damage from the subprime mortgage crisis to supporting lending in general. The Fed also announced it would keep the fed funds rate at zero through 2013 at minimum.
Through Operation Twist, the Fed was moving investors away from ultra-safe Treasurys into loans with more risk and return. Demand for Treasurys was still high, thanks to concerns over the eurozone debt crisis. By intentionally lowering yields, the Fed was forcing investors to consider other investments that would help the economy more.
The policy worked. In June 2012, the yield on the 10-year Treasury fell to 200-year lows. As a result, the housing market started to come back, as did bank lending. Other factors helped, but the Fed's leadership through Operation Twist was a consistent guiding light.
Operation Twist ended in December 2012, when the fourth round of quantitative easing was announced. Since QE4, yields on Treasurys and other securities have gradually increased.
Many criticized the Fed's actions. They said that despite the expansionary monetary policy, the economy wasn't growing. Unemployment remained high because businesses weren't growing and creating jobs.
Unfortunately, the Fed can only do so much. Bernanke warned several times that legislators needed to head off the fiscal cliff. Businesses remained cautious, despite the availability of cheap loans. The Fed chair basically said the Fed had the gas pedal to the floorboards, but couldn't overcome the uncertainty created by the fiscal policy stalemate.
Why Operation Twist Didn't Create Jobs
On June 20, 2012, the Federal Reserve announced it would extend its "Operation Twist" program until the end of the year. It will also keep the Fed funds rate at current low levels through 2014. In his presentation at Capitol Hill, Chairman Ben Bernanke asked elected officials to resolve the uncertainty around the fiscal cliff, taxes, and regulations. That had to occur before businesses recovered the confidence to get back on the hiring track.
High unemployment rates are due to two factors: cyclical unemployment and structural unemployment. Cyclical unemployment is caused by the recession, an often devastating phase of the business cycle. Structural unemployment is what happens when the long-term unemployed lose the skills needed to compete in the job market.
What are some unemployment solutions? Redirect some of the $740 billion being spent on national defense to more jobs-intensive efforts, such as construction. Then tie extended unemployment benefits with on-the-job training and internships. Most of all, the government must rise above partisan election-year politics and negotiate a solution to the fiscal impasse.
Operation Twist, or any other Fed program, can't do much to reduce unemployment because liquidity is not the problem. In other words, there is little that expansionary monetary policy can do to spur the economy. The problem is low confidence among business leaders. Whether it's the eurozone crisis, the fiscal cliff, or regulations, businesses aren't willing to hire until they are sure the demand will be there. The solution must come from Washington and Brussels.
History of Operation Twist in the 1960s
The original Operation Twist was launched in February 1961. It was named after a dance made popular by singer, Chubby Checker. The Federal Reserve began selling its holdings of short-term Treasury bills, trying to raise yields. It wanted to encourage foreign investors to park their cash in these bills, instead of redeeming the cash for gold.
At the time, the United States was still on the gold standard. Foreigners who sold products in the United States would just exchange it for gold and so deplete reserves in Fort Knox. Without gold reserves, the U.S. dollar was not as strong or powerful. As U.S. affluence grew after World War II, consumers imported more and more. Today, we no longer worry about the gold in Fort Knox because President Nixon abandoned the gold standard in the 1970s.
The Fed also wanted to boost lending by lowering yields on long-term Treasurys. The economy was still recovering from the recession of 1958, which was brought on by the end of the Korean War.
Operation Twist was a bold Fed action. Fed Chair William McChesney Martin allowed himself to respond to President John F. Kennedy's request to buy long-term notes and lower the interest rate. Other Fed Board members were resistant to the "political influence." But Operation Twist did work to boost the economy by raising short-term rates. It wasn't aggressive enough to lower long-term rates. But it did end the recession.