Fed Launches New Stimulus

Teni Sow | September 22, 2011 | 0 Comments

The Federal Reserve has unleashed another creative attempt to stimulate the economy, moving to increase its holdings in long-term securities in order to drive down long-term interest rates.

The Fed plans to sell $400 billion in short-term Treasury notes and buy $400 billion in Treasury securities that will mature in six to 30 years, in an attempt to encourage spending by consumers and businesses. The project has been dubbed “Operation Twist,” after a similar stimulus undertaken by the Fed in 1961.

The move would push interest rates on mortgages down, which the Fed hopes would encourage people to either buy homes, in turn stimulating the housing market, or refinance their mortgages at the lower interest rates, which would give them more cash to spend. More spending by homeowners could help spur a virtuous circle of hiring, increased income, and spending that reinforce one another.

But the program will not have a major impact on economic growth or unemployment, economists say.

“It’s not the missing link to an economic recovery,” said Mark Vitner, senior economist at Wells Fargo Securities.

Vitner told The Huffington Post that most people with good credit have already refinanced their mortgages, since interest rates are currently so low. He said that even if rates were to decrease further, it would not help people with bad credit — including the 23 percent of Americans who owe more than their home is worth — since they do not qualify for refinancing in the first place.

Operation Twist’s overall effect on the economy will be “marginal,” said Gregory Daco, principal U.S. economist at IHS Global Insight. Daco said that long-term interest rates, which are already low, have fallen even lower because investors have been expecting this move from the Fed for a while. As a result, they have largely priced in the potential impact of Operation Twist, and interest rates may not be able to fall much more.

“I don’t think the Fed holds a magical wand that could all of a sudden solve the current situation of weak growth,” Daco told The Huffington Post.

Operation Twist may also be unlikely to make a dent in consumers’ reluctance to spend, since high unemployment continues to diminish people’s confidence in the economy.

“Homeowners are relatively insensitive to mortgage rates when they are lacking confidence,” Yale economist Robert Shiller, an expert on the housing market, told Bloomberg News. “The dramatic thing that is happening now is that their job isn’t secure, if they even have one.”

But there are some people “at the margin” who may decide to refinance their mortgages once long-term interest rates drop, said Gus Faucher, director of macroeconomics at Moody’s Analytics. The “tens of thousands of dollars” that people would save may encourage them to spend more, Faucher said, in turn stimulating the economy. The Fed’s move also could boost stock prices, which could make people feel wealthier and confident enough to spend.

At the very least, Vitner said of Operation Twist, “it doesn’t hurt.”

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