As the U.S. launches $400bn 'Operation Twist' in a desperate attempt to kick-start the economy, concerns arise over how effective this will be. It's true that something needs to be done and inflation restricts the options open to the Fed but the strategy has a poor track record in terms of effectiveness. We will be in a lower growth environment for longer and should prepare accordingly.
The Economy Struggles: Something Needs to be Done
The U.S. remains driven by consumer spending (~70 percent of GDP), but weak consumer confidence and limited access to financing are severe headwinds. Unemployment is stuck at 9 percent and even more worrying are the 'under-employment' figures which include those that have been forced to cut their working week rise as far as 18.5 percent of the population. In addition to discouraging spending, the longer this continues, the more skills are being eroded. Therefore the U.S. government is under an immense pressure to act.
But Inflation Restricts Options
So what can they do? When conventional monetary policy has become ineffective, since short-term interest rates are already low, that's where quantitative easing steps in. With the aim of stimulating the economy, the Fed will buy financial assets in order to inject money into the markets. Bernanke has made it clear that one of the pre-requisites is a re-emergence of deflationary risks. However, inflation remains stubbornly above 2 percent. Pumping more money into the markets increases its supply and therefore reduces its value. With the currency less valuable, it doesn't go as far as it used to and you get less 'bang for you buck.' Things seem more expensive and inflation has been boosted.
Operation Twist to the Rescue?
There is hope. One form of quantitative easing avoids the problem of inflation -- Operation Twist. The strategy still involves the Fed buying long-term government bonds, but in this case, it's offset with selling short-term bonds. This avoids flooding the market with cash which would exacerbate inflation. Another way this method is also described, by selling short-term bonds and buying longer term bonds, is an extending of the maturity of Fed's bond portfolio. Buying these long dated bonds increases demand and therefore reduces the amount of interest the bond issuer has to offer to entice buyers. A reduced longer term rate makes for example mortgages (long-term borrowing) more affordable which would hopefully encourage spending.
A Poor Track Record
History teaches that Operation Twist may be of limited use. When it was applied back in 1961, it only reduced rates by 15bps! This would not be enough to encourage spending, hiring and boost the economy sufficiently.
What Can You Do?
Prepare for a lower growth environment for longer. Pay attention to the type of customer a company in which you're interested in investing services. A strong balance sheet, pricing power and protected demand will serve firms well.
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2. Quantitative Easing decreases real consumer spending. It only increases quantity spending, at the new lower value.
3. To increase consumer spending you have to provide consumers money to spend. Consumers can't spend money they don't have.
4. Swindlers and scammers, hedge-funders, banksters and speculators, wholesale net-fished the consumer pond. No fish are left in the pond. This means no fish for consumers to catch, to sell, to get money to buy with.
Swapping premium fish species between private estate ponds doesn't put any fish back in the fished out consumer pond. If it puts more premium fish in markets it puts them there to rot. Consumers have no money to buy. To buy they have to get money from somewhere. they have to catch and selling regular fish. But there are no regular fish. All were stolen. The theft unbalanced the market. The marketplace is stagnant.
Can increasing money supply, decreasing money value, inflating prices, stimulate an unbalanced marketplace?
No.
You can't get something out where nothing is being put in. Fish in a pond, money in an economy, until you put in everything else you do is pretend. Rename your baits and lures whatever you like. you won't catch with them, fish or dollars, because the only ones to catch are ones you imagine.
In example, if you were writing of a religious Paradise, instead of an economic Paradise imaginary construction, you might be analyzing how climate-effect elements may exist in your Paradise so that they may provide Paradisically perfect pleasant weather event effectts to those whose concepts of paradise require them (breezes, spring rains, etc.) without imposing them on other dwellers in your Paradise whose ideas of Paradise are absent those.
For us who are not true-believers with you, who do not share your religious imagination (ecclesiastic or economic), you have to make a case for your "Paradise" existing in the first place. Here in our real physical, non-quantum-theoretic reality your imagined construction does not exist in the first place, wherefore its imagined weather effects cannot play.
A second problem is your using parochial jargon. You write, for an example, that a 1961 "operation twist" "only reduced rates by 15bps!" "bps" means nothing to we non-initiated.