1. Operation Twist
By: Belal Akhtar
The U.S. economy is stuck on neutral and needs to shift into overdrive. The economy will
not grow, or will grow at a very slow pace, for the next few years, and maybe even in the long
term. Unemployment is hovering around 9.1%, housing prices and the consumer confidence
index continue to decline. Not to mention, the situation in Europe is not raising investors’ hope
in global financial markets. So who will kick start the economy? Who will save the U.S. from
another recession, high unemployment, and bring back consumer confidence? Why the Fed of
course! Yes Ben Bernanke and company have decided to try something similar to quantitative
easing but this time it’s a little different; this time the steroid-overdosed Fed balance sheet will
not be injected with any more drugs. Instead this time it will take some small pills out and
replace them with bigger ones.
So what does this mean? First of all, as of the end of September, the Fed held $1.65
trillion worth of treasuries on its balance sheet; $1.45 trillion of these were short term (10 years
to maturity or less). In Operation Twist it plans to trade or sell $400 billion of its short term
treasuries in exchange for about the same amount of long-term treasuries, thus keeping the
balance on its balance sheet stable. The idea is to take advantage of the negative relationship
between interest rates and treasury prices by increasing the demand for long term treasuries, thus
increase their prices to lower long-term interest rates. Thus, this plan twists the yield curve or
flattens it so that long-term interest rates, typically higher than short term rates, become lower
than short-term rates, which will be pushed up due to the selling of short-term treasury securities.
The objective is to lower rates to stimulate spending and borrowing. With lower rates, the hope is
that businesses will not hesitate to borrow, banks and lenders will lend bonds at a higher price,
and investors will invest in riskier assets.
Still that does not mean that this plan is full proof. Questions are left unanswered such as
exactly how much to spend on long term treasuries and how much of an effect this strategy will
have on long-term rates. The Fed tried a similar strategy in 1961 but on a much smaller scale.
Economist debate the success of that policy, with long-term rates falling .1% to some falling 15
basis points or .15%. Many economists believe this policy was a failure and will not work again,
including those in the FOMC and in Bernanke’s inner circle. Not to mention, the opposition from
most of the Republican Party can make it very difficult for this plan to be fully implemented.
Proponents claim that this time the exchange will be on a much larger scale and the Fed has
learned from its past mistakes. The Fed believes that it cannot sit idly by and watch the U.S.
economy fall into another recession and therefore must do something, anything, to stimulate the
economy back, even drop the unemployment rate by half a percent.
Ben Bernanke has expressed that job creation is the Federal Reserve’s primary goal, but
Operation Twist probably won’t work in terms of getting private-sector employers to hire more
people. Interest rates are already at record lows (and will remain low until 2013) and still
unemployment remains stagnant. In fact the U.S. is in a liquidity trap, where interest rates cannot
go down any further, but it still feels like a recession. So even if the Fed succeeds in driving

2. long-term interest even lower, unemployment will continue to remain at around 9% at least for
the short term. Employers will realize the benefits of lower interest rates on money market
instruments such as treasuries, perhaps as early as the second quarter of 2013 but probably not
sooner. Instead the Fed should focus on and promote venture growth, especially in the
engineering, computer science, and science sectors of the economy, by making it easier for banks
to borrow from the Fed’s “discount window”. By making it easier for banks to borrow money
directly from the Fed, it will spur banks to make loans to growing ventures so they can expand
operations, invest in capital as well as advanced technology, and of course hire workers. Also,
the Fed may start thinking about letting banks hold less cash reserves at the Fed (less excess
reserves) so banks may lend more. Operation Twist is not a bad idea, but I feel there are better
policies out there that the Fed can use.
Fed’s long-term goals are to keep prices stable and keep unemployment down. Let’s see
if this strategy works and if it can fulfill both of these goals in the coming year.