Fed's 'Operation Twist,' Explained In 4 Easy Steps

Sep 20, 2011
Originally published on September 21, 2011 11:41 am

Note: Robert Smith has an Operation Twist explainer on Wednesday's Morning Edition, complete with soundtrack. The story's attached above.

The interest rate on 10-year Treasuries is 1.95 percent. This is crazy low. It's lower than inflation. But the Federal Reserve may be about to push the rate even lower.

The Fed has at its disposal one key tool: interest rates. So when Fed officials are worried about unemployment, they try to drive down interest rates, in an effort to encourage people and businesses to borrow and spend.

And with unemployment over 9 percent (and core inflation at 2 percent), the Fed is likely to keep hammering away, trying to push down interest rates.

The Fed will announce its next move on Wednesday afternoon, at the close of a big, two-day meeting. That move is expected to be something known as "Operation Twist."

Here's what it means.

1. The Fed already owns more than $1 trillion in bonds, purchased over the past few years in an effort to bring down medium- and long-term interest rates.

2. A lot of those bonds — hundreds of billions of dollars worth — are medium-term bonds, which come due in the next few years.

3. Interest rates on medium-term government bonds are already near zero.

4. The Fed may sell some of those medium-term bonds, and use the proceeds to buy longer-term bonds — such as 10-year Treasuries.

Operation Twist should, in theory, drive down the interest rate on 10-year bonds. (When demand for bonds rises, interest rates fall.) Lots of other interest rates — including mortgages — are tied to the 10-year Treasury rate. So this should drive down interest rates across the board.

But it's unclear how much effect the effort will have at this point.

The term "Operation Twist" comes from the early 1960s, when the Fed tried something similar. (It's named for the Chubby Checker hit.) It may have had a small effect — one recent study found that it drove down the interest rate on Treasury bonds by 0.15 percentage points. But the effect on mortgage rates was smaller, and the effect on corporate borrowing costs was tiny.

What's more, interest rates are already super low. And it's clear that the economy has lots of problems that lower interest rates alone can't solve. Fed officials know this, but there's not much they can do about it. All they can do is keep trying to lower interest rates.

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OK. While electric vehicle fans gather in Missouri, Federal Reserve policymakers are meeting today here in Washington, D.C. Interest rates in the United States are incredibly low right now. And it looks like the fed wants them even lower. One widely talked about move officials are considering has an unusual name. It's called Operation Twist. Robert Smith from NPR's Planet Money team put on his dancing shoes to explain how it could make borrowing even cheaper.

ROBERT SMITH: It is not a coincidence that Operation Twist sounds a lot like the dance craze from the '60s, because they share a common inspiration - Chubby Checker.


CHUBBY CHECKER: (Singing) Come on, baby. Let's do the twist.

SMITH: In the early '60's, there was a transformation on the dance floor. Up until then, boys danced with girls by actually holding each other. But after seeing Chubby Checker do the Twist, those kids dropped their hands, moved apart...


CHECKER: (Singing) And go like this...

SMITH: Meanwhile, at the Federal Reserve, the nation's economic leaders were coming up with a different crazy move.

RANDY KROZNER: Economists know about this. This is sort of a famous episode from the 1960s.

SMITH: Randy Krozner was once a governor of the Federal Reserve. Now he's a professor at the University of Chicago. And Krozner says that back in the early '60s, the country had some of the same problems we face today -a weak economy and a growing debt. And the Fed thought...

KROZNER: Well, maybe there's a way to bring down the financing costs for the government.

SMITH: The Fed came up with a plan to nudge down long term interest rates. In fact, they wanted it to be known as The Nudge. But come on, nobody wants to dance the Nudge. It became known as Operation Twist after the dance craze.


CHECKER: Hey everybody, get in line we're going to make a twist train...


SMITH: But the Federal Reserve has already driven these short term rates down to almost zero.

KROZNER: They've been hammering at that pretty hard, so they're looking for an additional hammer.

SMITH: The Fed needs another trick to perk up the economy. And all of a sudden that old dance was back in fashion.


CHECKER: (Singing) We're going to the twist and it goes like this. Come on, let's twist again like we did last summer. Yeah, let's twist again, like we did last summer. Yeah, let's twist again...

SMITH: So The Twist tries to twist down the interest rates on longer term loans. And the Fed does this buy buying and selling Treasury bonds out in the marketplace. They basically sell a bunch of short-term bonds that they have lying around. And the Fed will use that money buy up a bunch of longer bonds, say 10-year Treasury bonds. And that demand helps push the interest rates down.

KROZNER: Ten years because a lot of home mortgages are closely associated with the 10-year rate.

SMITH: I mean just think about houses. There are a lot of reasons why people don't buy homes. Maybe they fear losing their job or they think that prices are still heading down.

KROZNER: The interest rate is one very important price but it's not the only one.

SMITH: Antulio Bomfim is one of the economists who did the study. And he says there is only so much the Federal Reserve can do by just manipulating the interest rates. He says the Fed is like Chubby Checker dancing by himself without any help from the Congress or the president,

ANTULIO BOMFIM: Monetary policy cannot do this alone, in terms of helping bring the economy back to a better footing at a faster pace.

SMITH: Yes, so perhaps The Twist is the wrong metaphor here because the Federal Reserve needs a partner.

BOMFIM: Needs a partner.

SMITH: They need to waltz or something.

BOMFIM: Yes. Yes. Yeah, that's a good one.


SMITH: Robert Smith NPR News, New York.


THE BEATLES: (Singing) Ahh, ahh, ahh, ahh, ahh. Well, shake it up, baby now. Shake it up, baby. Twist and shout. Twist and shout. Come on. Come on. Come on. Come on, baby now. Come on, baby. Come on and work it on out?

GREENE: And you're listening to MORNING EDITION from NPR News. Transcript provided by NPR, Copyright NPR.