Operation Twist simply explained

The Federal Reserve is going to try pushing the interest rate on 10-year treasuries to a new low. Already at 1.95 percent, the Fed is launching "Operation Twist" in an effort to jumpstart the sagging economy.

LOS ANGELES, CA (Catholic Online) - The Federal Reserve uses interest rates as a tool to get people borrowing again. By reducing interest rates, the logic goes, financial institutions can borrow money more cheaply. That money is then spent, or rather invested, to make more money. Hopefully, the financial institution makes money on the investment.

In the process of investing, financial institutions loan money to businesses and people who in turn spend the money in ways that create jobs and stimulate the economy. As the funds are paid back, the financial institutions make profits and reinvest those, and continue to loan and collect as the economy grows once again. 

Today, with unemployment around 9 percent, no net gain of jobs during the month of August, and talk of another recession, the Fed has initiated Operation Twist.

Operation Twist will see the Fed sell some of their medium-term bonds, with interest rates near zero, in an effort to raise money. That money will then be used to buy longer-term bonds such as the 10-year treasuries. As the Fed buys up 10-year bonds, the interest rates should drop because in this case, when demand for bonds goes up, the rates fall. 

Tied to these rates are other rates, such as mortgage rates. Driving mortgage rates down yet further will enable more people to borrow, and therefore buy, which will hopefully provide some stimulus to the economy. 

Unfortunately, the Fed has long ago made the big cuts in interest rates that might make the most difference. These cuts will likely suffer from the economic law of diminishing marginal utility.  Still, in an economy as battered as this, any help is useful, and any effect will be appreciated no matter how marginal it is.   

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