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Operation Twist

Essay by   •  November 22, 2011  •  Essay  •  687 Words (3 Pages)  •  1,651 Views

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To stimulate the economy, the Federal Reserve announced "Operation Twist" that it intends to sell $400 billion of shorter-term Treasury securities by the end of June 2012 and buy longer-term Treasury securities. The Fed is hoping that this program would lower the long-term interest rates by reducing the supply of longer-term Treasury securities in the market as the Federal Reserve website says. There are some components of "Operation Twist" that need to be discussed.

Operation Twist would stimulate the economy by easing financial market conditions with lower long-term interest rates. Over the last two years, the Fed acquired $1.65 trillion of federal bonds. Some of them will mature in short period of time, which is less than two years and some of them in 30 years. When the Fed purchases long term securities, the supply of long term securities would be reduced and demand would exceed the supply. This in turn will increase the price of the bonds, which lowers yield. And consequently long term interest rates and bank lending interest rates would be lowered as well. So it would be cheaper to borrow money to invest in their business in the market which will lead to lower yields.

Then more people would create more businesses and consumers would spend more money. If new businesses were established, more employers would hire more people. And with lower interest rates, more households would purchase new houses so that the overall investment would become more active.

Another element of the program is that as Financials Times says, the Fed will not increase its currency unlike 'its previous rounds of quantitative easing.' It's reinvesting its portfolio toward long term securities and taking more risk by investing long term securities but not investing more money. It is just trying to influence the economy with their assets instead of creating more currency. Thus the balance sheet is fixed while it is easing the monetary policy.

However, there are some downsides of Operation Twist. First of all, interest rates are already at lows since 2008. And the loan demand has not gone up over the last six to nine month even with the low interest rates, according to Frank Sorrentino, CEO of North Jersey Community Bank. Consumers are still afraid to take more loans even with the lower rates.

In general, major loans follow the long term Treasury securities. The national average 30 year fixed mortgage interest rate, which is the most popular type of mortgage, is 4.09 percent already. The rate is the lowest in six decades according to the article in Huffington post. With the Fed's move, it would go down below 4 percent. This shows that it wouldn't significantly affect the investors to take loans to buy houses or cars as Mark Zandi, the chief economist at Moody's Analytics said.

Additionally, this currency policy most likely would hurt the profitability of pension fund which is

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