Economic Essay

To stimulate the economy, the Federal Reserve announced "Operation Twist" that it intends to sell $400 billion of shorter-term Treasury securities by the end of June 2012 and buy longer-term Treasury securities. The Fed is hoping that this program would lower the long-term interest rates by reducing the supply of longer-term Treasury securities in the market as the Federal Reserve website says. There are some components of "Operation Twist" that need to be discussed.

Operation Twist would stimulate the economy by easing financial market conditions with lower long-term interest rates. Thus, the supply of long term securities would be reduced and investors are forced to pay higher prices. And interest rates would be lowered consequently. So it would be cheaper to borrow money to invest in their business in the market. If new businesses were established, more employers would hire more people.

The Fed would also try to help homeowners by reinvesting proceeds from maturing investments in mortgage-backed securities with mortgage interest rate target. And as a result, the liquidity would be increased in economic activities. Corporations would increase their investment and more households would purchase new houses so that the overall investment becomes more active. And unemployment rate would decrease.

Another element of the program is that as Financials Times says, the Fed will not increase its currency unlike 'its previous rounds of quantitative easing.' It's reinvesting its portfolio toward long term securities and taking more risk but not investing more money as New York Times said. It is just trying to influence the economy with their assets instead of creating more currency. Thus the balance sheet is fixed while it is easing the monetary policy.

However, there are some downsides of Operation Twist. First of all, interest rates are already at lows since 2008. And the loan demand has not gone up over the last six to nine month, according to Frank Sorrentino, CEO of North Jersey Community Bank. Consumers are still afraid to take more loans even with the lower rates.

As a matter of fact, it can be seen in the long term Treasury securities. In general, major loans follow the long term Treasury securities. The national average 30 year fixed mortgage interest rate, which is the most popular type of mortgage, is 4.09 percent already. The rate is the lowest in six decades according to the article in Huffington post. With the Fed's move, it would go down below 4 percent. This shows that it wouldn't significantly affect the investors to take loans to buy houses or cars as Mark Zandi, the chief economist at Moody's Analytics said.

Additionally, this currency policy most likely would hurt the profitability of pension fund which is invested as riskless asset. The Fed sells an average of $14 billion in 30 year Treasury bonds each month and through Operation Twist, it