Op Twist and demand

The Federal Reserve announced further efforts to stimulate the U.S. economy yesterday by reapportioning the maturity of the bonds in its $2.6 trillion portfolio. The operation has been dubbed “Operation Twist” because it twists the yield curve by raising short-term rates and lowering long-term rates. This is another attempt by the Fed to goose consumers into spending and borrowing at higher levels in the hopes that it will increase demand and get the national economic engine running at a higher speed. Reuters reports:

The Federal Reserve’s latest effort to push down long-term U.S. borrowing costs may not do much for the central bank’s main worry — persistently high unemployment that could leave lasting scars on the economy.

Economists are increasingly anxious that the 9.1 percent jobless rate in the United States could become entrenched, as the skills of those out of work atrophy and their connections to the job market wane, sidelining them and chipping away at the U.S. economy’s capacity to produce.

The idea behind the move, nicknamed by investors as “Operation Twist” after a similar policy in the 1960s, is to push down long-term borrowing costs to encourage mortgage refinancing and consumer and business borrowing.

Undoubtedly Operation Twist will lower rates that municipal bond issuers will pay to raise new money and it’s likely that we will see a rush to refinance their higher interest bonds. The action will also cause municipal bonds that are already outstanding to rise in value. But the biggest question I have is will Op Twist stimulate demand from consumers? When we get the next set of quarterly state sales tax data from the Rockefeller Institute, will we see that consumers have loosened their purse strings and that they feel more confident about the their economic future? That is the true goal of the Fed’s actions to jump-start the animal spirits, which are so vital to economic recovery. So maybe a better name for the program would have been “Operation Shout.”