Operation Twist: Definition and Purpose
Operation Twist is a monetary policy tool used by the Federal Reserve to lower long-term interest rates when short-term policy rates are already near zero or when standard tools are constrained. The Fed conducts Operation Twist by selling short-term Treasury securities and using the proceeds to buy longer-term Treasuries. The combined action is intended to reduce long-term yields, flatten the yield curve, and stimulate borrowing, investment, and spending.
History and Context
- First implemented in 1961 to strengthen the U.S. dollar and encourage economic activity following a recession.
- Reintroduced after the 2008–09 financial crisis when the Fed sought additional stimulus while short-term rates were at or near zero.
- Considered a less aggressive alternative to large-scale asset purchases because it does not expand the Fed’s overall balance sheet.
How Operation Twist Works
- The Fed sells short-term Treasury bills and uses the proceeds to purchase longer-term Treasury notes and bonds.
- Bond prices and yields move inversely: buying long-term Treasuries pushes their prices up and yields down; selling short-term Treasuries pushes their prices down and yields up.
- Because the Fed typically commits to leaving short-term policy rates unchanged during the operation, the primary effect is a larger decline in long-term yields than in short-term yields—hence a “twisting” or flattening of the yield curve.
Economic Effects
- Lower long-term interest rates reduce borrowing costs for businesses and households (mortgages, corporate borrowing, long-term loans), which can boost investment and consumer spending.
- Reduced long-term yields can support asset prices and ease financial conditions broadly, helping to lower unemployment and stimulate growth.
- The operation primarily influences market-determined long-term yields; expectations about future Fed policy continue to drive short-term rates.
Limitations and Considerations
- Operation Twist does not increase the Fed’s balance sheet, so its stimulative capacity may be more limited than quantitative easing (QE).
- Market expectations and risk sentiment can blunt or amplify the policy’s effects; if investors expect future rate changes, the short end of the curve may move independently of Fed transactions.
- The magnitude of long-term yield declines depends on the scale of purchases and prevailing market liquidity—large or persistent demand elsewhere can offset Fed actions.
Comparison with Quantitative Easing (QE)
- Operation Twist: Reallocates the maturity composition of the Fed’s holdings (sells short-term, buys long-term) without expanding the balance sheet.
- QE: Involves net purchases of assets that increase the total size of the Fed’s balance sheet, injecting reserves into the banking system and usually having a broader liquidity effect.
Key Takeaways
- Operation Twist aims to lower long-term interest rates by swapping short-term Treasuries for long-term ones.
- It flattens the yield curve and is used when conventional rate cuts are not available or sufficient.
- The tool can ease borrowing costs and support economic activity, but its effectiveness depends on scale, market conditions, and investor expectations.
Sources
- Federal Reserve research on asset purchase programs and maturity transformation.
- U.S. Department of the Treasury daily yield curve data.