Fed Extends 'Operation Twist' — So What Is It?

Robert Siegel talks to Professor Alan Blinder of Princeton on the Federal Reserve's renewal of the so-called "Operation Twist."

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Well, if like me, you're more than a little mystified by Operation Twist, the Federal Reserve policy that's being extended, join me now for a four-minute tutorial. We've got a very classy tutor, economics professor Alan Blinder of Princeton, who is a former Fed vice chairman. Welcome back to the program.

ALAN BLINDER: Thanks very much, Robert.

SIEGEL: So here's one point I definitely don't understand. If by buying long-term bonds, say, 10- or 30-year bonds, the Fed drives up their price and drives down the interest rate on them, doesn't the act of selling shorter-term bonds have the opposite effect of making them cheaper and driving up interest rates? Why isn't it a wash? How does this help us?

BLINDER: Yes. You've got it exactly right, and there's the origins of the phrase operation twist, which dates back to Chubby Checker days. It does exactly as you say. It twists the yield curve. What - the yield curve is the name market people give to the relationship between the maturity and the interest rate. So just as you said, the intent is to push down, let's say, eight- to 10-year interest rates, but the other effect of the other side of the twist is likely to be push up one- to two-year interest rates.

SIEGEL: Well, since one and two years is much closer than...


SIEGEL: ...10 and 30 years...


SIEGEL: ...doesn't that have the contrary effect of stimulating the economy? Doesn't it - isn't bad to force up short-term rates?

BLINDER: The twist idea is based on the notion which may not be 100 percent correct - by the way, just - I've never been a great fan of twists...


BLINDER: ...but anyway, that the eight- and 10-year rates for costs - for example, they're tied to mortgages are more important than the one- or two-year rates which tend to be tied more to short-term business loans and things like that. But you put your finger on an absolutely correct point. There are people for whom and businesses for whom the one-year rate is more important than the 10-year rate. And they will - if this works as expected, be hurt, not helped. The people for whom the 10-year rate is the big deal are helped.

SIEGEL: But aren't, say, 30-year rates, if they're reflected in mortgage interest rates, aren't those already very low?

BLINDER: And so are 10-year rates, yes. Rates are very, very low, and this is one of the reasons that a number of people, including myself, are pretty skeptical that you get a lot of mileage out of twist. The rates recently - the 10-year rate has recently been flirting around the 1.5, 1.6, 1.7 range. That's incredibly low. The Fed can push it a little bit lower, but it tends to get swamped by other events, you know? If you watch this rate, its movements day to day - not today because everyone was watching the Fed, but its movement is day to day, have been much more dominated by what's happening in Europe.

SIEGEL: Than what the Fed itself is doing.

BLINDER: Than what the Fed has done.

SIEGEL: Yeah. Well, since the Fed has implemented operation twist after buying up securities in the policy and it was called quantitative easing - and since they did all of these things after bringing down interest rates, short-term interest rates as far as they could and since there's still a perceived need to do something, is the point here a double negative that more of Operation Twist may or may not do something good but stopping doing it would be something bad?

BLINDER: I think that was exactly the reasoning. I don't think, you know, Chairman Bernanke has probably spoke more favorably about Operation Twist than I did. And by - and it is better than nothing. But I don't think people on the Fed really think this is going to make a huge difference to the economy. The problem they face, and it's a real - it's a genuine problem - is they don't have any heavy artillery left. You know, they used the heavy artillery long ago. Then they used the rifles. And now, they're down to bows and arrows and rocks and things like that.

SIEGEL: OK. Well, thanks for explaining it to us.

BLINDER: You're welcome.

SIEGEL: That's Professor Alan Blinder of Princeton, former Fed vice chairman, helping me understand - I hope you as well - what Operation Twist is all about.

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