The Federal Reserve’s “Operation Twist”

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The U.S. Federal Reserve's latest method to stimulate the economy, called “Operation Twist,” has recently been in the news. The name for this strategy came about in the 1960s when Chubby Checker’s song, “The Twist,” was popular. The last time the Federal Reserve utilized this method of stimulus was after the late 1950s and early 1960s recession during the Kennedy administration.

The Federal Reserve is selling $400 billion of short-term treasuries over the next nine months. This is designed to lower long-term interest rates. In turn, this will raise short-term interest rates, those under 90 days or shorter maturities in duration.

 

Implications

The strategy this time is to drive down long-term mortgage rates to stimulate the housing market, which is stuck at around 600,000 annual starts instead of the normal 1.1 million. Another strategy is to spur more investment through low-cost borrowing. Both of these strategies may be trumped on the fiscal side of the equation due to the regulatory burden on existing small businesses and startups.

Another factor impacting the success of this strategy is the high unemployment rate. Over 9% reported, and over 16% unemployment when U-3 to U-6 workers are included, is not conducive for a robust housing market. In other words, the housing market will not return to normal unless people have the cash flow to actually make mortgage payments. This being said, it could be a very difficult long time for housing to rebound.

The bottom line is that Operation Twist and some of the other Federal Reserve strategies, particularly in the past 12 months, while accommodating, will not bring much of a surge to the U.S. economy. In the U.S. and abroad, the political uncertainty is moving the U.S. economy and possibly the world economy toward a recession, if another black swan or unusual event occurs.

As a side note, the Operation Twist strategy will reduce the profits in lending as margins are crushed by the flattening of the yield curve, both at the short-term maturities and long-term maturities. This may have a major impact on the banking industry and fuel additional consolidations.

 

Editor’s note: Dave Kohl, Corn & Soybean Digest trends editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at sullylab@vt.edu.

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