"The Twist" is back in vogue in D.C. but Republican lawmakers are fleeing the dance floor. Today, Federal Reserve Chairman Ben Bernanke is rumored to announced a plan dubbed "Operation Twist," in reference to the 1960s dance craze, that will move money in its $1.7 trillion portfolio "out of short-term securities and into longer-term holdings." It's designed to boost the slumping economy by lowering rates on mortgages "and other consumer and business loans," reports the Associated Press. However, last night Republican leaders, including Mitch McConnell and John Boehner, sent a letter to Bernanke urging him to resist new efforts to lower interest rates. So what is this new Twist and what are the pros and cons for implementing it? Here's a rundown:
Where the term comes from Jacob Goldstein at NPR explains:
The term "Operation Twist" comes from the early 1960s, when the Fed tried something similar. It may have had a small effect — one recent study found that it drove down the interest rate on Treasury bonds by 0.15 percentage points. But the effect on mortgage rates was smaller, and the effect on corporate borrowing costs was tiny.
What happens in practice if the policy is enacted Phillip Inman at The Guardian explains:
Over the last two years of quantitative easing, the Fed has acquired a hand that includes $1.65 trillion of federal bonds – in other words, loans to the US government. Some of these bonds will mature in one or two years, some not for much longer – up to 30 years. If the Fed trades in some of its shorter-dated bonds for more of the longer-dated alternatives, demand for the longer-dated variety will exceed supply. This in turn will drive up the price of those bonds, which depresses the "yield" – the effective rate of return the holder of the bond gets on their investment. The yield determines the interest rate. Lower long-term interest rates will lead to lower 25-year mortgage rates, car loans and other bank lending rates.
The case against it David Malpass at The Wall Street Journal explains his opposition to it:
Wall Street and Washington gave the Fed hurrahs for its low interest rate bubble policy in 2004-2006. The motto was "dance till the music stops." More Fed purchases would hurt savers by lowering, for example, CD yields, add to market uncertainty, further distort short-term credit markets, and worsen the Fed's conflict of interest in setting interest rates, because its bond portfolio will lose value if it raises rates.
The case for it Marc Chandler at Credit Writedowns hopes Bernanke endorses the idea:
Some observers suggest that further policy action is likely to be negative for the dollar but we strongly disagree. Taken together, an announcement in line with our expectations for Operation Twist would generally expected to be more positive for the dollar. Reason being, is that Operation Twist is just a duration shift along the yield curve and therefore would not lead to an expansion of the balance sheet. What’s more, with the 2-year yield already at record lows a duration shift is likely to send the front-end of the curve marginally higher, which in turn is also likely to be more supportive of the dollar through the relative 2-year yield spread.
The case against Republicans getting involved Ezra Klein at The Washington Post says the lawmakers are not helping the situation:
So sure, this letter isn't threatening to do anything now. It's just making clear that the Republican leadership in Congress is strongly opposed to any further attempts to help the economy. It's the subtext that Bernanke and others will find threatening: The Republican Party is unified in its backlash to the Federal Reserve, and they may well be in power two years from now. Does Bernanke really want to provoke them? Is that really a good thing for his institution? In other words: Nice central bank you got here. Shame if something should happen to it.