The Federal Reserve Board’s Federal Open Market Committee has decided to rebalance its portfolio, buying more long-term securities and selling short-term securities, in an effort to drive down long-term interest rates. It is hoped that this will stimulate additional investment on the part of businesses and lower borrowing costs for consumers – possibly by incentivizing more home refinancings.
This rebalancing is known in monetary circles as the “twist” as it was last attempted in 1961 when the Twist was a popular dance trend. Research from the Federal Reserve Bank of San Francisco has suggested that the early 1960s experience lowered interest rates by 15 basis points (or 0.15 percent).
“Operation Twist” – as it has been dubbed – was widely anticipated with media stories leaking out in the past couple weeks about this new initiative. Specifically, the “Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasuries with remaining maturities of 3 years or less.”
In general, the Federal Reserve reiterated its desire to keep interest rates “exceptionally low” through mid-2013. It cited weak economic growth and its dual mandate of combatting both inflation and high unemployment in making its decision. Referring to the economy, the press release states:
Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased. Investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable.
Once again, this decision was not unanimous. Presidents of three regional Federal Reserve Banks – Richard Fisher (Dallas), Narayana Kocherlakota (Minneapolis), and Charles Plosser (Philadelphia) – voted against the decision. Each of them continues to worry about inflationary pressures in the economy. In making this action, though, the remaining seven FOMC members felt that slow economic growth trumped concerns about pricing pressures. It is notable that the statement adds, “… the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.” This sentence was added to no-doubt placate those which worry that the Fed’s actions will spur inflationary tendencies.
In the end, though, this approach is different from the first two rounds of quantitative easing in that the Fed is purchasing securities through rebalancing instead of by printing additional money. This seems to me to be a nod towards the critics of “QE” and “QE2.” What’s more, it is an attempt by the Fed to try something different (since it was last attempted over 50 years ago).
For manufacturers, this means that interest rates will remain low, but it also suggests that the Federal Reserve remains quite worried about economic growth moving forward. Yet to be seen is how effective it will be. Interest rates are already low, so pushing them lower might have a limited impact, particularly if businesses and consumers remain anxious about the economy and continue to curtail their spending.
Chad Moutray is chief economist, National Association of Manufacturers.