Bloomberg News

The Twist and Shout Should Be the Fed’s Next Maneuver: View

September 20, 2011

Sept. 21 (Bloomberg) -- Markets today are expecting the Federal Reserve to announce Operation Twist, a financial maneuver aimed at rescuing the U.S. recovery.

Like the Chubby Checker song, the twist will involve some gyrations. The idea is to flip the maturities of the Fed’s $1.65 trillion bond portfolio by selling short-term Treasuries and buying longer-term ones. The move would aim to bend down the interest rates charged on home mortgages, car loans and other big-ticket items in the hope of inducing more consumer borrowing and spending, and greater business investment. The Fed may also lower the interest rate it pays banks on the reserves they keep at the central bank, encouraging them to lend rather than hoard the money.

Unfortunately, the twist probably won’t have much effect. The last time the Fed tried something similar -- in 1961, when “The Twist” was actually atop the hit parade -- it managed to lower long-term rates by a mere 0.15 percentage point, economists estimate. In a 2004 paper, Fed Chairman Ben S. Bernanke himself pooh-poohed the move. Now, with unemployment high, many households still deep in debt and with mortgages tough to get, such a small step is unlikely to generate much spending.

So how can Bernanke make a difference? More aggressive action is a tough sell, given the need to navigate between the minority, but very vocal, camp of Fed policy makers who worry about inflation, and the majority -- including him -- who fear a double-dip recession. In this instance, then, it won’t come down to policy so much as words of explanation, something Fed chairmen have been fairly stingy with over the decades.

Muted Effect

Words, however, seem to be the only way to quell the criticism leveled from the campaign trail -- criticism that has confused the public and muted the effect of the Fed’s easing efforts.

It would be helpful, for instance, if Bernanke explained why he thinks inflation, which at 2 percent is now at the upper limit of the Fed’s preferred range, is not a problem? Which indicator should the Fed care about most in the current environment: unemployment, growth or inflation? What would it take to justify a third round of bond-buying, or quantitative easing?

At last month’s meeting, the Fed pledged to keep its benchmark interest rate near zero until at least mid-2013, more clearly defining what it meant by an “extended period.” It could further influence expectations by promising to stay near zero until unemployment falls to, say, 7 percent -- assuming inflation remains in check.

Job Creation

Still, the Fed can achieve only so much. The federal government’s ability to spur job creation is greater -- by spending on roads, bridges and schools, and by giving tax incentives to business. So Bernanke must also be clear that the Fed’s actions could have limited effect, and that the real solution lies with Congress and President Barack Obama agreeing on fiscal policy.

The politicization of the Fed is not the chairman’s doing, but it behooves him to push back against those who denounce the Fed for using unconventional methods to rescue an economy that can’t seem to get its groove back. Instead of just twisting, Bernanke needs to twist -- and shout.

--Editors: Paula Dwyer, Mark Whitehouse

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To contact the Bloomberg View editorial board: view@bloomberg.net.


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