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