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Operation Twist: Quantitative Easing

Posted on June 20th, 2012 | Author: Robert C. Gabrielski

Guest Blogger: William R. Doane

Following the Fed’s April 4th meeting, it had seemed unlikely that a possible QE3 would be engaged.  Support for the monetary policy had dwindled and the economy boosting program seemed to have a sluggish future. However, following the conclusion of a two-day meeting in Washington, QE3 is not just likely, QE3 is here. Bernanke, Chairman of the Federal Reserve, announced today that they will be extending “operation twist” by twisting $267 billion worth of short term bonds into long-term bonds.  The Federal Reserve made clear that it is “prepared to take further action as appropriate to promote a stronger economic recovery and sustain improvement in labor market conditions in a context of price stability.”

In explanation of this bond-buying program, the twist goes as follows: (i) the Fed would sell short-term bonds, and (ii) uses those funds to buy long-term bonds.  Their monetary goal is to raise short-term interest rates, which are still extremely low, and reduce long-term interest rates, essentially by “twisting” the yield curve.  The economic goal is to stimulate the economy and create jobs.

What should last through the end of 2012, the monetary policy’s main goal of bringing long term interests rates closer to zero, should lead to an eventual slow increase in economic growth. Although growth is expected to be moderate in the next few upcoming quarters, economists are hoping to possibly see the unemployment rate dip back to 8%, which recently has just increased from 8.1% to 8.2%, and has been above 8% since February 2009.

In conclusion, along with the announcement of the “Operation Twist” extension, the Federal Reserve has lowered growth outlook with new projections regarding GDP, unemployment rates, and percentage of inflation. The GDP is expected to be between 1.9 and 2.4%, the unemployment rate to be between 8.0-8.2%, and the percentage of inflation is estimated to be down to anywhere from 1.2 to 1.7%.  It will be interesting to see the effectiveness of the newly extended monetary policy and its effect on unemployment rates and economic growth.

In his Q&A with reporters following the meeting, Bernanke noted a few things in his answers to questions, one of them throwing a barb at Congress.  Basically, Bernanke noted that while the Fed still has some remaining tools, albeit limited, it continues to be up to Congress to get together to further stimulate the recovery.  Bernanke also noted that the uncertainty with Europe is palpable, but the Fed stands ready to assist.

At this point, the Fed continues to assist Europe with liquidity, particularly by making funds available to northern EU countries in their effort to prop up southern EU.  Will that be enough to help some southern EU countries avoid melt down and further slow the U.S. recovery?  Stay tuned as the Fed continues to twist, again.

 

Bob Gabrielski contributed to this post.