Bernanke Puts New ‘Twist’ on Old, Failed Policy

Published September 22, 2011

“Operation Twist” is the name that’s been given to the Federal Reserve’s program to move hundreds of billions of dollars of the Fed’s investment portfolio into longer-term debt, but critics say it’s a new twist on an old policy that failed in the 1960s.

Ironically, three Federal Reserve economists in 2004 wrote, “Monetary Policy Alternatives at the Zero Bound:  An Empirical Assessment,” which reviewed the 1960s Twist operation and concluded it was a failure.

One of the three authors of that report was Ben S. Bernanke, the current Federal Reserve chairman who in 2004 was a member of the Fed’s Board of Governors.

“Launched in early 1961 by the incoming Kennedy Administration, Operation Twist was intended to raise short-term rates (thereby promoting capital inflows and supporting the dollar) while lowering, or at least not raising, long-term rates. (Modigliani and Sutch 1966) . . . ,” they wrote. “The two main actions of Operation Twist were the use of Federal Reserve open market operations and Treasury debt management operations. Operation Twist is widely viewed today as having been a failure, largely due to classic work by Modigliani and Sutch.”

Bernanke Thinking Bigger is Better

Bernanke and his co-authors said the failure may have been due to the small size of the operation: $8.8 billion. A key aim of today’s much larger Twist operation, much like the one 50 years ago, is to move the Federal Reserve’s money from short-term to long-term debt, thus driving down long-term interest rates. Bernanke announced the contemporary version of Operation Twist on Sept. 21, after the Fed’s Open Market Committee voted 7-3 to approve it.

“The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative,” the Fed said in its official statement.

The statement added, “To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction. The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent . . . .”

‘A Test on Entire Economy’

Robert Wenzel, editor and publisher of, noted in a blog post at his site, “Yes, the current Fed chairman is the man who wrote that the first Operation Twist was a failure and that it was possibly so because it wasn’t large enough — and he is now testing the US economy to see if a greater size Operation Twist will work differently! Since I have long contended that Bernanke is something of a mad scientist, using the United States economy as his personal laboratory, this move by Bernanke has just exploded my Bernanke mad scientist detector. I repeat, for all practical purposes, he is running a test on the entire economy to determine if, as suggested in his 2004 paper, Operation Twist might work out differently if run on a grander scale.”

Economist and financial advisor Robert Genetski said the Fed’s statement “was extremely disappointing. The Fed announced plans to buy $400 billion of long-term debt and sell an equal amount of shorter-term securities. This action is more likely to create additional problems for financial markets and the economy. “

‘Policymakers Have Not Learned Anything’

Genetski said “the same Keynesian framework that created the financial meltdown continues to guide Fed policy. Keynesian economic theory tends to promote manipulating interest rates to control the money supply and liquidity. Fed policymakers overwhelmingly subscribe to this theory” and “have not learned anything from the mistakes they made leading up to the financial crisis.”

He said the level and shape of the yield curve for interest rates are the consequence of complex forces to which markets have responded.

“The Fed has decided it knows better than the market where specific interest rates should be,” Genetski said. “As such, the Fed’s announced action is a form of price controls. Bureaucrats at the Fed have decided to replace the market’s judgment of where specific interest rates should be with their own judgment. Given the complexity of markets, attempts to override the market’s judgment with those of bureaucrats are more likely to have negative than positive consequences.”

What to Make of Desperate Policies?

Economist Mark Thornton of the Mises Institute in Auburn, Ala., said the Fed’s second round of “quantitative easing” that was launched in 2010 to buy $600 billion of Treasury debt “hurt the dollar and helped stocks, while Operation Twist helps the dollar and hurts equities. What are markets to make of all these desperate policies of Bernanke?”

He also said with the Fed owning so much debt, it must hold interest rates low to avoid hurting itself.

“Higher rates would be a problem for the Fed because it would decrease the market value of its bond and mortgage holdings considerably. I saw this possibility coming a couple of years ago. Apparently so did the Fed because it changed its accounting rules so that they would not be required to write down the accounting value of its holdings and therefore could not be embarrassed by going into bankruptcy status.”