Thursday, March 8, 2012

Operation Twist Doubles as Sterilized QE

Yesterday Jon Hilsenrath of the Wall Street Journal, who doubles as spokesman for the Federal Reserve, published an article titled 'Sterilized' Bond Buying an Option in Fed Arsenal. Upon word of another possible round of quantitative easing (QE), stocks and commodities rallied as the dollar fell against most other currencies. In the article, Hilsenrath comments that:
Under the new approach, the Fed would print new money to buy long-term mortgage or Treasury bonds but effectively tie up that money by borrowing it back for short periods at low rates.”
The first comment that jumped out was this notion of the Fed ‘printing money’. QE is nothing more than the Fed merely exchanging one financial asset (Federal Reserve notes) for another financial asset (Treasury bonds). Following the exchange, the private sector still holds the same exact amount of net financial assets. Asset durations in the private sector change, but QE alone will not cause inflation. Mike Norman expands on this issue and more in The Fed's "new and improved" QE.

Apart from this misconception of ‘printing money’, the specific durations that the Fed might buy and sell piqued my interest. Just last September Operation Twist was enacted, whereby the Fed purchased long-term Treasury bonds in exchange for short-term Treasury bonds. Read the description of Sterilized QE again. Under this program, the Fed plans to buy long-duration bonds and sell short-duration bonds. The size of the Fed’s balance sheet remains the same. Aside from the possible inclusion of long-term mortgages, Operation Twist and Sterilized QE are, in practice, exactly the same.

The Fed appears to have recognized the ineffectiveness of QE on the real economy, resolving to adjust perceptions by changing the name of its programs. While this may encourage greater speculation in stocks, commodities and MBS once again, one has to wonder how many versions of QE the Fed can perform before investors realize the truth behind these actions.


  1. You rightly point out that the new and improved QE is not a form of money printing and only an attempt to push the yield curve down at longer intervals. An exchange of assets on the fed's balance sheet does not therefore increase the money supply and inflation in and of itself. The value therefore of the new sterilized QE (if there is any) is that is a symbol by Ben Bernanke that he will continue to provide monetary support for the economy. If the markets predict that is the case, inflation expectations are likely to rise. So while you say QE is ineffective, I say it is effective if and only if Bernanke is attempting to increase nominal expectations.

    1. Ryan,

      Thanks for commenting. We clearly agree on most aspects of this plan. I question whether QE at this point, when liquidity is not an issue, is actually monetary support or simply trying to game nominal expectations.

      The issue with trying to increase nominal expectations is that the Fed/Bernanke have very little control over which assets are purchased . If food and energy prices are the primary benefit, the result may even be deflationary over a medium time-frame (few years).

      So you are correct that it is probably effective given the goal of increasing nominal expectations. Whether or not that benefits economic growth appears far less clear or certain.