Twisting In The Wind

In the card game 21s, a player can ‘twist’ to get another card from the dealer in the hope of reaching an aggregate face value of his hand of exactly 21. More often it is done in hope rather than expectation. So with the U.S. Federal Reserve’s latest attempt at stimulating the U.S. economy, Operation Twist. Banish the thought that this could be called QE3. After all, the Fed’s second round of quantitative easing did not achieve much in the way of generating additional demand to get the U.S. economy growing at anything but the most sluggish pace. It faces the same uphill battle with Operation Twist, intended to nudge down long-term interest rates as QE2 was intended to push down short-term ones. (Historic footnote: when the Fed tried the same tactic in 1961 it was originally called Operation Nudge)

Operation Twist will work like this: Between now and the end of June next year, the Fed will buy $400 billion dollars in Treasury bonds with maturities of 6-30 years. It will finance these purchases by selling an equal amount of debt with maturity of 3 years or less. In this way it will lengthen the average maturity of its debt holdings but does not need to expand its balance sheet to do so. Creating demand for longer-term bonds should drive down their yield.

Yet the U.S. economy already has very low interest rates by historic standards, and has, by now, had them for some time. It is not the cost of credit that is the issue but the demand for it. Large companies are awash with cash. They have neither the need to borrow, however cheaply, nor, more importantly, for as long as they see no increase in final demand for their goods and services, the appetite to invest that would require borrowings. Similarly with individuals. Mortgages, which are tied to long-term interest rates, are already cheap, for those who can get them, or want them. The housing market in the U.S. is not only battered but frozen. The lack of consumer confidence under the long dark shadow of persistent high unemployment is keeping it so. So neither companies nor individuals are prepared to commit the spending needed for a sounder recovery. Easier monetary conditions won’t make any significant impact on that.

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Filed under Fiscal Policy, Interest Rates, Macroeconomy, Monetary Policy

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