Federal Reserve Launches Controversial New Policy

21 Sep

The Federal Reserve Bank has enacted a new policy called Operation Twist in hopes to stimulate the still struggling U.S. economy. The plan essentially is trying to lower interest rates to encourage Americans to spend and borrow money again. Republicans have voiced their dissatisfaction with this idea saying that the current interest rates have been low for some time and they have, as yet, not successfully tempted Americans to spend or borrow money. This policy is even hotly contested within the Fed itself where multiple regional bank presidents have voiced their opposition to the plan. Only time will tell if this policy will work, it looks like the federal government is trying anything at its disposal to attempt to fix the waning economy, however small the chances may be according to experts.

By Annalyn Censky

The Federal Reserve announced “Operation Twist” Wednesday, a widely expected stimulus move reviving a policy from the 1960′s.

The policy involves selling $400 billion in short-term Treasuries in exchange for the same amount of longer-term bonds, starting in October and ending in June 2012.

While the move does not mean the Fed will pump additional money into the economy, it is designed to lower yields on long-term bonds, while keeping short-term rates little changed.

The intent is to thereby push down interest rates on everything from mortgages to business loans, giving consumers and companies an additional incentive to borrow and spend money.

“This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accomodative” the Fed said in its official statement.

It’s controversial to say the least, especially following a high-profile letter from Republicans earlier this week, urging the central bank not to intervene in the economy more than it already has.

And even within the Fed, three regional bank presidents, Richard Fisher of Dallas, Narayana Kocherlakota of Minneapolis and Charles Plosser of Philadelphia, dissented against the decision. Those same three dissented in August.

While the launch of Operation Twist was widely expected, experts still question its effectiveness. Interest rates have already been at record lows since 2008, and that has yet to entice consumers to take out loans.

Operation Twist: Investors want the unexpected

“This is not a situation where people are saying, ‘gee, I really want to buy that house but interest rates are too high’,” said Frank Sorrentino, CEO of North Jersey Community Bank. “Rates are already at historic lows and over the last six to nine months, we have not seen loan demand go up.”

Plus, the Fed could lose money on longer-term Treausries because inflation could outpace the interest rate over time, cutting into the returns on the bonds.

The Fed is also trying to help homeowners specifically, targeting mortgage rates by reinvesting proceeds from maturing investments in mortgage-backed securities. Previously, the Fed had been reducing its holdings of mortgage securities to reinvest that money in Treasuries instead.

“It’s a moderate way of having an effect on the housing market,” said Justin Wolfers, economics professor at University of Pennsylvania’s Wharton School. “Those who refinance will find more money in their pocket at the end of the month.”

Let’s twist again

But many economists today view the policy as a failure, arguing that it may have been too small to have a significant impact.

Totaling $8.8 billion, the original Operation Twist was roughly equal to 1.7% of the total U.S. economy in the early 1960′s.

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