March 4, 2021

Strategies: Federal Reserve Considers a Revival of ‘Operation Twist’

Ben S. Bernanke, the Federal Reserve chairman, hasn’t actually put it that way. But in his search for ways to improve the lamentable state of the economy, he seems to be contemplating the revival of an old dance that was once all the rage at the Federal Reserve and the Treasury.

What’s the Fed considering, exactly? It might embark on some arcane financial engineering, shifting the bonds within its own portfolio to bring down longer-term interest rates even further than they have already dropped. That’s been tried before, notably in 1961, in a once-obscure episode of Fed history known as “Operation Twist.” Some of the techniques used then may be coming back into vogue because the economy needs help and it’s not clear where it will come from.

Europe is awash in financial and fiscal problems of its own, Japan is struggling, and China’s economy is slowing, noted Robbert Van Batenburg, head of research at Louis Capital Markets. And while President Obama on Thursday proposed a $447 billion program to spur growth and job creation, the Republican leadership in Congress was initially unenthusiastic about much if not all of it.

“The surprise here was that the president’s program was about $100 billion more than the markets had anticipated,” he said. “That’s good. But problem No. 1 is, it isn’t clear how much, if any of it, Congress is likely to pass.”

The Fed, meanwhile, has already used some of its most powerful weapons — like holding short-term interest rates near zero at least through mid-2013, and buying more than $1.8 trillion of fixed-income securities as part of a bid to bring down longer-term rates.

So in a series of speeches, including one on Thursday in Minneapolis, Mr. Bernanke has been saying that the Fed is reconsidering the entire “range of tools” at its disposal to stimulate the economy. It may be time to try something a little different.

How about the Twist?

Cue the summer of 1960. Chubby Checker’s version of “The Twist” soared to the top of the charts. America was swiveling its hips. Fast-forward to Feb. 2, 1961. The glamorous new president, John F. Kennedy, elected on a pledge to “get the country moving again,” made his first major official speech on the economy, which was then formally in recession. He announced his own program to stimulate the economy and to fight unemployment, then an unpalatable 6.8 percent. (Today it’s much worse, at 9.1 percent.)

Embedded in that speech was an unorthodox monetary policy that the Fed and Treasury were to conduct jointly. It was known within the Fed as “Operation Nudge,” because it involved nudging interest rates by altering the composition of the Fed’s portfolio. That name, though, didn’t catch on. (As far as we know, nobody was dancing the Nudge.)

Wall Street gave the new program another name. “In a kind of homage to the dance craze, traders started calling it, ‘Operation Twist,’ ” says Eric Swanson, an economist at the Federal Reserve Bank of San Francisco who has done extensive research on the operation’s effects. “Somewhere along the way, that name stuck,” he says.

Twist is a more apt description of what the Fed was actually doing — swinging longer-term rates in one direction (down), while moving short-term rates the other way. Raising short-term rates made sense at the time because the world was still on a gold standard, and President Kennedy wanted to stimulate the economy without exacerbating a balance-of-payments deficit that was draining American gold supplies. He wanted to bolster the dollar — by raising short-term rates — while giving the economy a lift by bringing down longer-term rates.

Here the steps in the monetary dance get a bit technical. They include selling some of the Fed’s short-term securities and buying longer-term ones, effectively extending the average duration of the Fed’s own portfolio. Because bond prices and yields move in opposite directions, increased purchases of longer-term securities could be expected to drive up prices and drive down interest rates, and vice versa. Today, presumably, the Fed would manipulate its portfolio to lower longer-term rates, but in contrast to 1961, it would hold short-term rates near zero.

A number of scholars — including Mr. Bernanke, when he was a professor at Princeton and a member of the Fed’s board of governors — have concluded that the first Operation Twist was only modestly successful. But Mr. Swanson’s recent research, using contemporary high-frequency techniques to measure the bond market’s short-term response to Fed and Treasury operations, suggests that it actually had a significant effect on long-term Treasury yields.

The yields fell by an average of 0.14 percent (14 basis points), Mr. Swanson says, a shift roughly equivalent to the effect of cutting short-term rates — which can’t be cut now because they’re near zero — by a full percentage point.

“In normal times,” he said, “a drop like that might boost output by a percentage point over the next couple of quarters.”

WHATEVER else they may be, however, these are not normal times. It’s not clear how much effect a shift in the Fed’s portfolio might have right now, he said, but “it might help and it might be worth trying.”

With financial markets weighed down by myriad problems across the globe, Fed policy makers can be counted on to be inventive, said Kathy Jones, fixed-income strategist at Charles Schwab. Long-term bond yields have already started to drop as the markets anticipate some new variation on Operation Twist, she said.

At the Fed, Ms. Jones said, “they are making it clear that they will do whatever they need to do, or whatever they can dream up, to help the economy.”

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