Tags: carr | Operation | Twist | Hurt | economy

‘Operation Twist’ Will Hurt More Than it Helps

By Michael Carr   |   Wednesday, 28 Sep 2011 09:09 AM

The Federal Reserve has decided to force long-term interest rates down with its plan to buy long bonds while selling off short-term securities.

This $400 billion program is known as "Operation Twist" and modeled after a similar plan the Fed used in the early 1960s.

In the first Operation Twist, economic historians estimate the Fed succeeded in pushing long rates down by about 0.5 percent. A similar level of success this time could have catastrophic effects in the economy.

Lower interest rates lead to reduced interest income and lower consumer spending levels. This is often overlooked but could be a significant drag on employment.

Recent academic research has shown that every 1 percent decrease in interest rates leads to half a million lost jobs. If that happens under Operation Twist, unemployment would likely remain unchanged through at least the end of the year as slow job creation in the economy would be offset by the Fed’s job destruction.

Also, under normal market conditions, banks make money by paying low, short-term interest rates on deposits and charging higher, long-term interest rates on loans.

If banks were to pass the savings from low interest rates on to businesses and consumers, they would make even less on loans and could struggle to keep up with mounting losses on real estate loans.

Higher interest rates help pension funds and insurance companies meet their obligations, boost consumer spending, and help banks remain profitable.

With Operation Twist, all of those activities could suffer, and the economy could be worse if the Fed succeeds.

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The Federal Reserve has decided to force long-term interest rates down with its plan to buy long bonds while selling off short-term securities. This $400 billion program is known as Operation Twist and modeled after a similar plan the Fed used in the early 1960s. In...
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2011-09-28
 

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