The Federal Reserve's 'Operation Twist' is the wrong medicine at the wrong time. It has succeeded in stoking sentiment that our economic ship is in much more dire straits than has been previously revealed. Recent history shows that our economic situation is in a bad way. The 'twist', which I view as an act of desperation, evidences that our economic state is in an evermore dilapidated state.
This is like the Fed throwing sticks and pebbles at a hillside in hopes of starting an avalanche. The energy needed to rejuvenate our economic metabolism is wholly underwhelming in this latest effort.
Two reasons show why this is poorly timed, ineffectual medicine. First, the 'twist' involves a reshuffling on the Fed's bond portfolio from short-term to long-term bonds, with the intended effect of driving down interest rates on big ticket items such as mortgages (the intended target) and similar secured loans. Three years of the same have shown that another real estate bubble will not re-inflate.
The go-go days of property and mortgage speculation squeezed much of the natural market for real estate out of the near-future pool of buyers. As such, the growth of new debt where the Fed wants debt to expand is thwarted because of dour consumer sentiment toward major purchases coupled with a depleted pool of customers.
Consumers today generally are in no mood to take on new debt when unemployment is stuck at an achingly high level. Job security in this economic environment is an issue for so many who might otherwise take the plunge on a long-term commitment like the purchase of a home. Even smaller purchases stats are sagging. Businesses complain in successive surveys that two things weigh down success: insurance costs and a lack of customers. The Fed's effort, effectively a bond swap, will not remedy that situation.
The second aspect of the 'twist' that stands to be wholly inappropriate compares to previous efforts of the Fed. A reshuffling of the bond portfolio from short to long will only benefit specific strata of our financial system. Banks will certainly benefit, as will hedge funds and bond funds. The boons are just as likely to trickle down to the layers of economic strata that need the most help as they have in the past. In other words – not at all.
Another misguided prima facie intent of this effort emerges. This is an effort to stimulate growth through business investment (a.k.a. borrowing) at very low rates. That simply will not work under the current circumstances in which every major indicator shows recessionary levels of demand. This places more impetus on government to step in and fill the void left by private industry.
Government asserting its proper role during this economic crisis has little to no chance of happening with the House of Representatives controlled by an enthusiastically ignorant conservative wing. With the austerity mantra in their tiny little heads, there is so little the Fed can do with monetary policy to counter jarring consequences resulting from the stinking religion of today's tea-addled conservative.
So what does the Federal Reserve intend to accomplish with the 'twist'? Does it hope that cheap debt will substitute for business income when consumer demand is so low? If so, that is a form of economic cruelty. It also shows that monetary policy alone cannot rescue us from this situation. Fiscal policy, such as good ideas presented in the latest Obama jobs bill, combined with complimentary monetary policy from the Fed will offer some respite from this malaise.
Cross-posted at Macroindex