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The Fed Does the Twist The Fed Does the Twist

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ECONOMY

The Fed Does the Twist

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The central bank, headed by Chairman Ben Bernanke, said it will shift the balance of its $2.6 trillion bond portfolio from short-term to longer-term debt through the $400 billion purchase of longer-term Treasury securities by the end of June 2012.(Jonathan Ernst/Getty Images)

As expected, the Federal Reserve announced on Wednesday it will shift the balance of its bond portfolio in an effort to drive down long-term interest rates, so-called Operation Twist.

The announcement followed the Federal Open Market Committee’s two-day discussion of options. Operation Twist was the most widely anticipated outcome, although there was no agreement on the likely size and maturity mix of the shift.

 

The central bank said it will shift the balance of its $2.6 trillion bond portfolio from short-term to longer-term debt through the $400 billion purchase of longer-term Treasury securities by the end of June 2012. The Fed left interest rates unchanged.

Three members of the committee dissented from the move. Richard Fisher, Narayana Kocherlakota, and Charles Plosser, who also disagreed with the Fed’s decision in August to hold the federal-funds rate at rock-bottom levels through mid-2013, said they did not support additional policy accommodation at this time.

The dissent reveals the divisions within the Fed over the best way to tackle the country’s economic woes consistent with its dual mandate of maximum employment and price stability. Some FOMC members, such as Chicago Fed President Charles Evans, have urged aggressive monetary easing and a commitment to keep rates low until employment dips to 7.5 percent or lower from its current 9.1 percent, so long as inflation remains below 3 percent.

 

But Fisher, the Dallas Fed president, said in a speech earlier this month that the “bar for such action remains very high” until the country’s fiscal authorities—Congress and the president—put forth programs to encourage growth.

In a highly unusual move, congressional GOP leaders sent a letter to Fed Chairman Ben Bernanke on Monday urging the Fed to refrain from further action. The letter, signed by House Speaker John Boehner, R-Ohio, House Majority Leader Eric Cantor, R-Va., Senate Minority Leader Mitch McConnell, R-Ky., and Senate Minority Whip Jon Kyl, R-Ariz., warned that the central bank risked exacerbating the country’s economic woes.

Markets, which had priced in an Operation Twist-style move, wavered in advance of the FOMC statement and dropped following the announcement, closing sharply lower. The Dow Jones industrial average, which was around 22 points down when the statement was released, ended the day 283 points down.

The name “Operation Twist” derives the 1960 hit song “The Twist,” which Wall Street traders thought was a good description of the central bank’s move implemented in 1961. (The Fed had initially called it “Operation Nudge” because it would nudge down interest rates).

 

It’s unclear how much the move helped in the 1960s. And skeptics today point out that interest rates are already so low it’s unlikely Operation Twist could have much of an impact.

The Fed statement comes a day after the International Monetary Fund cut its projections for U.S. economic growth to just 1.5 percent in 2011, down from an initial 2.5 percent projection in June. Given the downside risks facing the economy, the Fed should “should stand ready to deploy more unconventional support, and the pace of fiscal consolidation could become more backloaded provided credible medium-term measures are adopted,” the IMF said.

The FOMC reiterated it would continue to review the range of policy tools available to it and is prepared to use them “as appropriate.” The committee is next scheduled to meet on Nov. 1 and 2.

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