After yesterday’s press release by the Fed, many commentators started talking about “Operation Twist” even though no such thing is mentioned in the release. Accompanying the press release on the Federal Reserve site, was, however, a document containing the term in parenthesis. Some could immediately be confused or even scared by this. Would this be yet an addition to the endless series of acronyms that has emerged during the financial crisis? Troubled and Worthless Interest-bearing Securities Task-force?
Luckily not. It just reflects a return to the old days. And “twist” actually means what it says: “twist.” In 1961, the Kennedy administration and the Fed engaged in an operation of selling short-term bonds and buying up longer term bonds. The aim was to “twist” the yield curve, and since it was in the days of Chubby Checker’s hit seen in the clip, the connotation to the dance was made.
People may not be dancing the twist anymore in the US, but nevertheless the Fed is now trying to twist the yield curve: Until June 2012 it will sell for $400 bn. in short-term bonds and buy up long-term bonds in an effort to lower yields on long-term bonds and their close substitutes (say, mortgage bonds). Yet another “unconventional” move (in addition to quantitative easing), now that the policy rate is essentially at zero (the decision on the policy rate was left unchanged, and as was the specific mention of how long it would be kept low; see earlier post on this). The goal is to live up to the part of the Fed’s dual mandate focusing on maximum sustainable employment.
The announcement has already had some effect. The yield on a 30-year government bond is down 35 basis point (from 3.20% Wednesday morning to 2.85% Thursday at 1 pm). The issue is whether much more can be expected when the Fed actually starts doing the twist? Most believe that it didn’t work in 1961, and even if it works a little, on may doubt whether this is sufficient in a situation with persistent and high unemployment. It may, on the other hand, not be damaging, except for the fact that the consolidated public sector afterwards will have a debt that costs more interest.
Another matter is that the Fed now have exhausted all of Ben Bernanke’s ways of “Conducting Monetary Policy at Very Low Short-Term Interest Rates” as listed by Bernanke and Vincent R. Reinhart (2004, American Economic Review 94, 85-90): I. Shaping Interest-Rate Expectations; II. Altering the Composition of the Central Bank’s Balance Sheet; III. Expanding the Size of the Central Bank’s Balance Sheet.
So, what will come next?