The Fed Expands Its Fight to Lower Long-Term Interest Rates

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In a modest bid to kickstart the economy, Fed chief Ben Bernanke is expanding a Federal Reserve program called "Operation Twist," which is aimed at reducing unemployment by lowering interest rates, by selling $267 billion worth of short-term bonds to purchase longer-term debt. The program was scheduled to end this month but will be extended now to the end of the year. Markets slumped following the news, as some investors hoped that Bernanke would do more to boost the economy such as a third round of quantitative easing.  Bloomberg NewsThe Wall Street Journal, and Reuters all have good initial coverage.

In its statement, the Federal Open Market Committee said continuing Operation Twist  “should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative." What in the blazes does that mean?

Late last year, NPR's Jacob Goldstein wrote a good explainer on Operation Twist after it was first enacted. The Fed's direct control over interest rates is for short-term borrowing by banks and other large institutions. But a lot of economic activity that creates jobs are governed by longer-term interest rates which the Fed can only indirectly influence. The idea is that by using short-term bonds to buy long-term debt, the Fed can reduce those longer-term rates and prompt businesses and individuals to borrow and spend more money that will in turn get the economy going and create more jobs. In sum, Goldstein writes:

Operation Twist should, in theory, drive down the interest rate on 10-year bonds. (When demand for bonds rises, interest rates fall.) Lots of other interest rates — including mortgages — are tied to the 10-year Treasury rate. So this should drive down interest rates across the board.

Will this latest effort be enough to get the economy back on track? Financial experts are divided on whether the Fed should do more. David Jones, chief economist at DMJ Advisors, told The Washington Postthe decision will only have a small effect. “This move is largely symbolic.” Meanwhile, John Canally, an investment strategist at LPL Financial, said this gives investors what they expected while leaving the door open to further action by the central bank. “If there’s another misstep somewhere — in Europe ... more weak data — the Fed’s going to do more,” he said. He told The Post the Fed wants to "keep some powder dry" in case something unexpected happens, such as a total economic implosion in Europe. 

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