Federal Reserve’s Operation Twist: Did It Work?

Federal Reserve's Operation Twist Did It Work

Operation Twist is a quantitative easing initiative used by the Federal Reserve. While long-term notes and bonds have a length of between six and thirty years, short-term instruments mature in three years or less, therefore the operation is said to take a “twist” when the Fed uses the earnings from its sales of short-term Treasury bills to purchase long-term Treasury notes. The central bank usually buys fresh short-term bills to replace the ones it has already purchased.

Operation Twist reduces the yields on long-term Treasury securities in order to lower longer-term interest rates. By using the proceeds from short-term bills to buy long-term notes, the demand for Treasury notes is increased. The price increases as demand grows, just like with any other asset. Lower investor yields, however, offset rising bond prices.

How does that lower interest rates? The yield on 10-year Treasury notes serves as the standard for interest rates on all fixed-rate loans. These include mortgages and loans for homes, furniture, and cars. Moreover, businesses can grow more affordably with reduced fixed rates. Consequently, the economy is expanding.

The Federal Reserve’s chairman, Ben Bernanke, announced the $400 billion

Operation Twist will be shown in September 2011. The Fed bought longer-term Treasury notes and bonds with the maturing proceeds from short-term Treasury bills and notes. The Fed would also buy new mortgage-backed securities as the old ones matured. The Fed could also buy long-term Treasury bonds with the proceeds from MBS, if it felt that was necessary.

The change in direction suggested that Bernanke was shifting the focus of the central bank from reducing the effects of the subprime mortgage crisis to encouraging lending more widely. Additionally, the Fed stated that it will, at the very least, keep the fed funds rate at zero until 2013.

Through Operation Twist, the Fed was steering investors away from extremely safe Treasurys and toward loans with greater risk and return. There was still a substantial market for Treasury securities because of concerns about the European financial crisis. By deliberately lowering yields, the Fed drove investors to consider alternative investments that might be more beneficial to the economy.

The policy worked. In June 2012, the yield on the 10-year Treasury hit 200-year lows. Bank lending and the housing market both started to improve as a result. Even with the support of other components, the Fed’s leadership during Operation Twist was a steady source of encouragement.

Operation Twist ended in December 2012, when the fourth round of quantitative easing was revealed. Since QE4, the yields on Treasury and other securities have gradually increased.

Heavy rebuke was leveled at the Fed’s activities. They said that in spite of the expansionary monetary policy, the economy was not growing. The unemployment rate remained high because firms weren’t growing and creating jobs.

Sadly, the Fed’s authority is constrained. Bernanke frequently encouraged lawmakers to stop the fiscal cliff from happening. Despite the availability of inexpensive financing, companies remained cautious. The Fed chair effectively admitted that despite pushing hard, the Fed was unable to overcome the uncertainty brought on by the fiscal policy deadlock.

What Prevented OpTwist from Creating Jobs

On June 20, 2012, the Federal Reserve said that it would keep up “Operation Twist” until the end of the year. Additionally, it will hold the Fed funds rate steady until 2014 at its current low levels. During his speech on Capitol Hill, Chairman Ben Bernanke urged public servants to address the uncertainty around the fiscal cliff, taxes, and regulations. That had to take place before businesses could feel confident again and start hiring again.

High unemployment rates have two main causes: cyclical unemployment and structural unemployment. Cyclical unemployment is a result of the recession, a particularly destructive phase of the business cycle. People who are out of work for a long time lose the abilities needed to compete in the labor market, which leads to structural unemployment.

What are some unemployment remedies? Spend some of the $740 billion allocated for national defense on initiatives that will boost employment, such as construction. Subsequently, tie extended unemployment benefits to training opportunities like internships and jobs. To begin with, the administration must set aside election-year party politics in order to find a path out of the current economic gridlock.

Operation Twist or any other Fed strategy won’t be able to significantly cut unemployment because liquidity is not the problem. In other words, a broad monetary policy has a limited potential to boost the economy. The problem is a lack of confidence among firm executives. Due to the fiscal cliff, the eurozone crisis, or restrictions, businesses are unwilling to hire unless they are positive that there will be a demand. The solution must come from Washington and Brussels.

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