Thursday, September 22, 2011

The Fed to implement “Operation Twist”

The Federal Open Market Committee concluded its meeting Wednesday, September 21, 2011, with no change in its traditional policy instrument, the federal funds rate. This interest rate is the rate at which banks borrow from each other. The Fed believes that the factors affecting the economy in a negative way are temporary. No change in short term interest rate policy is warranted.

Economic growth remains slow, employment is not increasing fast enough to lower the unemployment rate, but inflation is moderating.

However, the Federal Reserve System has decided to implement “Operation Twist”. This action is to gradually increase the average maturity of the securities that the Federal reserve own. The table shows the current distribution of securities owned by the Fed.

Current Distribution 0f Securities Owned by the Fed
as of September 2011
Treasury Bills (less than 1 year)
$18,423 million
Notes & Bonds (2 year – 20 year)
$1,631,024 million
Mortgage back securities (acquired to support banks during the financial crisis)
$884,945 million

Operation twist would result in the Fed selling short term securities (3 year maturity or less) and buying equal numbers of longer term maturities (6 years – 30 years) and to replace the mortgage backed securities as they mature.

The purpose of this action is to put downward pressure on longer term interest rates, including mortgages and corporate bonds. This should increase borrowing for home purchases and capital expansion by business.

A major concern of the Fed and a reason for the continuing slow recovery is that while banks have money to lend, they are simply holding these as excess reserves.

Bank Reserves as of
September 2011
Bank Total Reserves
$1,660,440 million
Bank Excess Reserves (94.5% of total)
$1,568,590 million
Bank Required Reserves
$91,850 million

In normal times, banks hold few excess reserves.  Prior to the financial crisis in August 2008, bank excess reserves were 4% of total reserves compared to 94.5% in September 2011. Today, banks are holding vast amounts of excess reserves. We will not see a normal recovery from the recession until banks start lending their excess reserves. Operation Twist is designed to increase demand for these funds.

No comments:

Post a Comment

Note: Only a member of this blog may post a comment.