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2012-06-26 11:35:32
The Federal Reserve extends Operation Twist
Jun 23rd 2012 | Washington, DC | from the print edition
THE Federal Reserve cannot be accused of sitting on its hands. On June 20th it
announced its seventh instalment of unconventional monetary policy since
running out of orthodox ammunition in late 2008, when short-term interest rates
fell, in effect, to zero. In its latest salvo, the Fed said it would purchase
$267 billion of long-term bonds by the end of the year, paid for from the
proceeds of sales of short-term bonds in its portfolio.
The move extends a programme, nicknamed Operation Twist, announced last autumn
and due to expire this month, under which the Fed has swapped $400 billion of
short-term bonds for long-term ones. Previous initiatives have included
purchasing bonds with newly created money ( quantitative easing , or QE),
reinvesting the proceeds of maturing bonds, and verbally committing to keeping
rates near zero for ever longer periods. All are designed to drag long-term
interest rates down in the hope of stimulating demand.
Like its predecessors, this latest round of monetary easing was motivated by
the economy s failure to grow as quickly as the Fed had forecast. Members of
the Federal Open Market Committee (FOMC), the Fed s main policymaking body, now
expect growth of between 1.9% and 2.4% this year, down sharply from their April
forecast of growth between 2.4% and 2.9%. This time a year ago, FOMC members
were expecting growth of about 3.5% in 2012.
They also downgraded their outlook for the next two years. They expect almost
no improvement in unemployment, now 8.2%, in 2013. And although the Fed set an
inflation target of 2% in January, many Fed officials apparently expect to
undershoot it between now and 2014.
The big question, given these downbeat forecasts, is why the Fed has not acted
even more aggressively. The pessimistic answer is that it cannot do more. In
theory, QE allows unlimited purchases of debt, of many different flavours. But
Ben Bernanke, the Fed chairman, frets over the risks of doing so: a bigger
balance-sheet that is harder to shrink later; impaired markets; and financial
instability, a euphemism for bubbles. What the Fed would really like, he said,
is for Europe to fix its crisis and America s politicians to avoid the fiscal
cliff , the near-simultaneous squeeze of tax increases and spending cuts
programmed to occur at year-end.
A more optimistic answer is that, before long, the Fed will do more. Mr
Bernanke promised the Fed will act if needed. At present, it is trying to sort
through the economic data to figure out how much of the recent weakening in
America s economy is real, rather than a statistical fluke. It is also awaiting
the outcome of events in Europe. Sadly, developments on both sides of the
Atlantic seem likely to lead to more action.
What form would such action take? By the end of the year, when the Fed has sold
the last of its short-term bonds, Operation Twist will have reached its limit.
That suggests QE would be the favoured option, particularly if the Fed can wait
until the election campaign is over and act without being accused of helping
one candidate or another. If the economy really appears to be heading over the
fiscal cliff, the Fed will not want to worsen the impact by holding back a
monetary cushion.
from the print edition | Finance and economics