16632_9.23_000016611434XSmall

Operation Twist Again

Sep 23, 2011 • 188 Views

Operation Twist is a great name but tough to understand.

Our starting point is interest rates. When you loan someone $100, you expect to be repaid more. How much extra? It depends on many variables so let’s just look at one.

Time.

When the federal government borrows money for 3 months, it has tended to pay less in interest than for its 10-year loan. (Not always, but that is another story.) Which graph demonstrates the long-term/short-term difference?

The yield curve.

The yield curve in this FDIC example shows the 10-year treasury interest rate minus the federal funds rate, a short term interest rate that banks charge each other. When the long term rate is high and short-term is low, the difference between the two is a positive number. However, what if the long term rate plunges until the short term rate exceeds it? Then, the difference is a negative number and the curve TWISTS downward.

Hence, Operation Twist.

Why “Operation Twist Again?” Because the same monetary maneuver was used 40 years ago during the Kennedy Administration.

Here is Chubby Checker singing “Let’s Twist Again.” (1961)

The Economic Lesson

Shown through this Marketplace.org whiteboard talk, unattractive long-term yield might make banks want to loan their money to businesses instead of buying long-term securities.

Here, USA Today talks about the potential impact of Operation Twist on each of us.

An Economic Question: How does yield relate to incentive?

« »