Fed Keeps Twisting to Lower Long-Term Interest Rates; Doubters Abound

Published June 21, 2012

Federal Reserve Chairman Ben Bernanke on Wednesday announced plans to expand “Operation Twist,” prompting some economists and financial experts to wonder why anyone would expect this move to succeed when similar ones have failed to achieve sustained economic improvement.

“Bernanke once again is going to the same well that he has visited for the past five years, and each time the positive returns grow smaller,” said William Anderson, associate professor of economics at Frostburg State University in Frostburg, Maryland.

“Each time he brings another bout of new money creation, be it QE1 or ‘Operation Twist,’ he further distorts the economy and makes recovery that much more difficult. While claiming to be digging the economy out of its depression hole, Bernanke actually is digging it deeper,” said Anderson.

Short Up, Long Down

“Operation Twist” is the name for a program to move hundreds of billions of dollars of the Fed’s investment portfolio into longer-term debt and out of shorter-term debt. The aim is to raise short-term interest rates while lowering long-term interest rates, which are already at or near record lows. QE is the abbreviation for quantitative easing, which the Fed has coined to describe its efforts to put more money into the economy by buying assets including government bonds and corporate assets.

Bernanke launched Operation Twist last September – the first Twist since the 1960s — after the Fed’s Open Market Committee approved the move. In its official statement at the time, the committee wrote:

“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.”

This week, after another Open Market Committee meeting, Bernanke announced the Fed would pour another $267 billion into the program. The Committee cited slowing employment growth and household spending as the reasons. The Committee also lowered its forecasts for economic growth through the rest of the year and raised unemployment estimates for the next three years.

Pushing on String

“Imagine a piece of string lying on a table. If you told a child to push on one end, he would notice that the other end doesn’t move. If you told him to push it a little harder, he’d look at you as if you were a little bit soft in the head, as the child implicitly understands Einstein’s definition of insanity as repeating the same action and expecting a different outcome. Federal Reserve Board Chairman Ben Bernanke seems, unfortunately, not as wise as that child,” said Ross Kaminsky, a professional derivatives trader and commentator on economics.

“From QE1 to QE2 to Operation Twist, Bernanke keeps pushing on an economic string which, as strings are wont to do, is not responding at the other end,” he said.

Kaminsky said he expects the Twist to have only a small impact on short-term interest rates because they “are more anchored by the near-zero 30-day Fed Funds rate.”

He said “nothing the Fed has done with their past attempts at ‘non-traditional’ monetary stimulus has seemed to benefit the economy — although they have distorted asset prices and caused periods of intense market volatility as traders speculate on the Fed’s next folly.”

In a question and answer session after his Wednesday press conference, Bernanke was challenged about the effectiveness of the Fed’s current monetary arsenal. He responded, “I wouldn’t accept the proposition, though, that the Fed has no more ammunition. I do think that our tools, while they are non-standard, still can create more accommodative financial conditions, can still provide support for the economy, can still help us return to a more normal economic situation . . . I do think that monetary policy still does have some capacity to strengthen the economy by easing financial conditions.”

‘More Confusion Than Stability’

Economist and economic and financial consultant Robert Genetski said, “This so-called ‘twist’ makes more sense as a dance than a policy. Attempting to manipulate interest rates is the Keynesian approach to monetary policy. It distorts market interest rates and introduces more confusion than stability into the financial system.”

Genetski said the Fed should be explaining to Congress how Dodd-Frank financial reform is “undermining” the banking system.

“This ‘reform’ has short-circuited the transmission mechanism and is preventing the Fed’s actions from boosting spending,” he said.

Kaminsky said Bernanke’s move also raises moral hazard concerns.

“By artificially lowering long-term interest rates, the Fed allows the U.S. government to appear to borrow less expensively than might otherwise be the case,” he said. “But it is effectively the U.S. government, in the form of the Fed, which is lending the money. What rational person wants to lend money to anyone, particularly to a government as addicted to waste as ours is, for 30 years at 1.6 percent? The Fed is making one of the riskiest bets in the history of finance.”

He added, “The low rates also mask the costs and likely future damage of federal spending. So what Bernanke is doing is like temporarily lowering the interest rate and raising the credit card limit for someone who is addicted to spending money. Not only is it stupid policy for the long-term health of our nation’s finances, it is adding to the already immorally high debt burden which the last generation, and particularly the last decade, of politicians have piled onto the backs of our children.”