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Operation Twist



Definition

Operation Twist is a monetary policy operation initiated by the U.S. Federal Reserve to adjust the yield curve and stimulate economic growth. It involves selling short-term Treasury bonds and using the proceeds to buy long-term Treasury bonds. This action aims to lower long-term interest rates to encourage borrowing and investment.

Phonetic

The phonetics for “Operation Twist” would be:Op-uh-rey-shuh n Tw-ist

Key Takeaways

  1. Monetary Policy Tool: Operation Twist is a type of monetary policy tool used by the United States Federal Reserve system to influence market conditions. Initiated twice, first in 1961 and then again in 2011, it aimed to lower long-term interest rates to stimulate economic growth.
  2. Bond Buying Strategy: The strategy involves the simultaneous selling of short-term Treasury bills and buying of long-term Treasury bonds without creating new debt. This shifts the demand for long-term bonds, pushing their prices up and yields down, thereby reducing the long-term interest rates.
  3. Economic Impact: Operation Twist was primarily designed to make borrowing cheaper for businesses and individuals, which should in theory encourage investment, promote economic growth, and reduce unemployment. However, the effectiveness of Operation Twist in achieving these goals has been a subject of debate among economists.

Importance

Operation Twist is a significant monetary policy tool used by central banks, especially the US Federal Reserve, to manipulate and stabilize the economy. Named after the 1960s dance craze, the ‘Twist,’ it involves the simultaneous selling of short-term government securities and buying of long-term government debts. This strategy aims to flatten the yield curve, reducing long-term interest rates and promoting economic growth without increasing inflation. By making long-term borrowing cheaper, it encourages businesses and consumers to take more loans for investment or spending, thereby stimulating the economy. Operation Twist is crucial for central banks as a non-conventional method to sway the flow of money and credit in the economy when traditional methods are not feasible or effective.

Explanation

Operation Twist is a monetary policy tool employed by central banks, like the U.S. Federal Reserve, to lower long-term interest rates in an attempt to stimulate economic growth. The methodology involves selling short-term government bonds and using the proceeds to buy long-term government bonds. By increasing the demand for long-term bonds, their yields or interest rates decrease, hence lowering long-term borrowing costs. Lower interest rates make it cheaper for businesses to borrow and invest in new projects, and for consumers to borrow and spend, thus boosting economic activity. However, it’s crucial to note that Operation Twist aims to achieve this economic stimulus without injecting additional money into the economy, thus avoiding the risk of inflation that can come with strategies like quantitative easing. Named after the Chubby Checker song that was popular around the time of its first use in the 1960s, Operation Twist is usually employed in periods of sluggish economic growth, where traditional monetary policy tools may have become less effective, or there is a need to avoid increasing the money supply further.

Examples

Operation Twist is a term coined during the 1960s to describe a monetary policy initiative of the U.S. Federal Reserve aimed at influencing market interest rates to stimulate economic growth. It involves the Fed buying and selling short-term and long-term government bonds in an effort to lower long-term interest rates. Here are some real-world examples:1. Operation Twist (1961): This was the first instance of such a move and hence came to be known as Operation Twist. The United States Federal Reserve done this in an attempt to flatten the yield curve, i.e., reduce the gap between the long-term and short-term interest rates. This was a means of boosting the economy by making long-term borrowing cheaper for businesses.2. Operation Twist (2011): The Federal Reserve attempted another Operation Twist in 2011 to help the U.S. recover from the slower-than-expected pace of economic recovery following the Great Recession of 2008. Initially, the program was set to end in June 2012, but was then extended to end in December 2012. The central bank purchased approximately $667 billion in long-term securities during this period.3. India’s Operation Twist (2019): The Reserve Bank of India implemented its own version of Operation Twist in 2019, through simultaneous sale and purchase of government securities. The aim was to manage the country’s yield curve and bring down the costs of borrowing for the government.These instances are examples of the same concept, but varying in their particulars according to the given conditions of the country’s economy and aims of the central bank at the time.

Frequently Asked Questions(FAQ)

What is Operation Twist?

Operation Twist is a monetary policy strategy carried out by the U.S. Federal Reserve. Its objective is to lower long-term interest rates to stimulate economic activity without causing an increase in inflation.

When was Operation Twist first implemented?

Operation Twist was first implemented in 1961 by the U.S. Federal Reserve and then again in 2011 in response to the financial crisis.

How does Operation Twist work?

Operation Twist works by the Federal Reserve selling short-term Treasury bonds and using the proceeds to buy long-term Treasury bonds. This increases the short-term interest rates and decreases the long-term interest rates.

What are the intended effects of Operation Twist?

The main intention is to stimulate economic activity. By lowering long-term interest rates, borrowing becomes cheaper. This encourages businesses and individuals to take out loans for investment and spending, which, in turn, stimulates economic growth.

Does Operation Twist increase the Federal Reserve’s balance sheet?

No, Operation Twist does not increase the Federal Reserve’s balance sheet because it involves selling short-term bonds and purchasing long-term bonds, rather than outright purchases of assets.

What is the impact of Operation Twist on the bond market?

Operation Twist can lower the yield of long-term bonds and raise the yield of short-term bonds. This could normalize the yield curve if it is inverted or steepen the yield curve if it is flat.

Can Operation Twist lead to inflation?

The design of Operation Twist is such that it aims to stimulate economic activity without increasing the money supply, and hence, it should not lead to inflation. However, like all monetary actions, it could potentially contribute to inflation if not done appropriately.

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