The Federal Open Market Committee action known as Operation Twist (named for the Twist dance craze of the time) began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market.
The maneuver is being referred to by some as “operation twist”, an expression that was originally used to describe a plan implemented by the Kennedy administration and the Federal Reserve in 1961, and given its moniker after a dance popular at the time.
Many have felt that Operation Twist is simply Quantitative Easing round 3. To those we say – not so fast Johnson – this operation is not QE3. Quantitative Easing is when the Fed buys long term bonds to force those rates down. However, with no accompanying asset sales, the Fed is essentially using cash (or electronic money) to buy.
The problem with Operation Twist is that there is little evidence that this will actually work to lower interest rates significantly. The last time this was attempted was nearly 50 years ago. At that time the reductions in interest rates achieved by the original Operation Twist were tiny. But of greater concern is the fact that the Federal Reserve continues to believe that lowering interest rates further will turn our ship around.
The Fed creates money to use in the bond purchases.
By the Fed purchasing government bonds, the aggregate affect on the economy will be a decrease in the amount of bonds available on the market and an increase in the money supply (this is the money the Fed uses to purchase these bonds).
Decreasing the available supply of bonds will increase the price of bonds thus pushing down their yields to maturity (interest rates).
Chairman Bernanke finds himself in a highly unenviable position. As head of the Federal Reserve, his mission is to ensure that unemployment and inflation stay in check.
By decreasing interest rates, saving will become less attractive to individuals and businesses, and thus more money will be borrowed and spent on consumption and investment.
The central bank said that it would buy $400bn of long-dated Treasuries, financed by the sale of an equal amount of bonds with three years or less to run.
Such a big move suggests that Ben Bernanke, Fed chairman, is alarmed by the slowdown, and has decided to override opposition on the rate-setting Federal Open Market Committee and provide as much stimulus as easily practical.
Operation Twist gets its name from the result it hopes to achieve. The Fed hopes to twist the bond yield curve and essentially bring short term rates up and force long term rates down.
'Operation Twist' is rumoured to be the Federal Reserve's latest attempt to stimulate the US's flagging economy.