Right Change: Fed Reserve Policy: Operation Twist or Operation Cliff?

The Federal Reserve’s announcement yesterday that it is extending “Operation Twist” through the end of 2012 means the economy may get a modest boost. The Fed will sell an additional $267 billion of short-term bonds and buy long-term bonds in an effort to lower long-term interest rates. The idea behind Operation Twist is to spur investment and try to bring already record-low mortgage rates even lower.

Bernanke said the Fed is willing to do more to boost the economy if hiring doesn't pick up:

"We'll continue to monitor the economy and see how things evolve. ... If we don't see continued improvement in the labor market, we're prepared to take additional steps." 

Steps could include "additional asset purchases," which likely would mean more purchases of Treasury bonds which in turn would continue to lower interest rates. 

Unfortunately the new Fed action comes with a deadline of Dec. 31, 2012, the same date the Bush tax cuts will expire if action is not taken. Many business and political leaders are calling this a “fiscal cliff” as the additional stimulus is withdrawn and Bush tax cuts and automatic spending cuts would kick in exactly at the same time. 

Bernanke warned  that the impending expiration of tax cuts early next year and imposition of big spending cuts, known as the "fiscal cliff," is already creating uncertainty that could slow hiring:

"Putting all these things together, you have a very substantial withdrawal of income from the economy that will affect spending and will affect the ability of the economy to recover."

The Wall Street Journal expressed, “Just what the economy needs: Another temporary stimulus that may or may not end when the powers in Washington claim it will.”

The Fed began Operation Twist last September, selling $400 billion of its short term securities while buying a like amount of Treasuries with six- to 30-year maturities. 

Has all of this monetary policy helped? The results have fallen short of the Fed’s expectations. Fed officials have reduced their forecasts for GDP growth to between 1.9% and 2.4% for this year’s down from 2.4%-2.9% just two short months ago.

Fed officials have obviously felt the pressure by the Obama administration to spur growth and stimulate the economy, but if cheap money were the answer, the economy should be booming already. Instead, each different infusion of monetary easing has boosted short term market optimism followed shortly after by a slow growth reality. Relying solely on monetary policy to promote growth has proven ineffective in solving our economic woes because it teaches the market to anticipate that more “easy money” is coming down the pipeline. We need to infuse confidence into our system, and that starts with supply-side fiscal and regulatory policies that gives business owners the confidence to hire more employees and plan in advance as to what their cost of doing business will be. 

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