Thursday, September 22, 2011

The Twist

For some reason, nine readable lines from a PDF turns into interminable fine print on the blog. I have taken one paragraph and an afterthought Eric Swanson's paper, and put a little breathing room between thoughts.


Let’s Twist Again: A High-Frequency Event-Study Analysis of Operation Twist and Its Implications for QE2

Eric T. Swanson
Federal Reserve Bank of San Francisco
March 14, 2011
(PDF, 34 pages.)
John F. Kennedy was elected President of the United States in November 1960 and inaugurated on January 20, 1961. The U.S. economy had been in recession since April of 1960 and the recession was ongoing (it would ultimately end in February 1961, although the level of economic activity would remain low for several months into the recovery).

The incoming administration wanted to stimulate the economy with easier monetary as well as fiscal policy, but European interest rates were higher than in the U.S., leading to substantial flows of dollars and gold to Europe under the Bretton Woods fixed exchange rate system. The Federal Reserve was very reluctant to lower short-term interest rates for fear of worsening the U.S. balance of payments and the outflows of gold to Europe.

The Kennedy administration’s proposed solution to this dilemma was to try to lower longer-term interest rates while keeping shorter-term interest rates unchanged. The idea was that business investment and housing demand were primarily determined by longer-term interest rates, while the balance of payments and gold flows were determined by cross-country arbitrageurs who act on the basis of short-term interest rate differentials.

Swanson's story continues:

If longer-term Treasury yields could be lowered without affecting short-term Treasury yields, the reasoning went, then investment could be stimulated without worsening the balance of payments and gold outflow.

Thus, on February 2, 1961, Kennedy announced to Congress a policy...

I was almost 12 years old. Mom had gone back to school to become a nurse. The daily paper cost 5 cents.

I went with her to some event at the college. People there were doing the Twist.

1 comment:

Jazzbumpa said...

So this whole thing twisted around gold flows and fixed exchange rates when 10 Yr T-Notes were paying 4.08% (average for Jan. '62, earliest data in FRED series GCS10.)

Now, exchange rates float, the gold standard is long gone, 10 Yr T-notes averaged 2.30% in August and 2.01% so far this month.

None of the conditions that made this worth doing (and, BTW it took a full 4 Yrs to work) apply.

This is simply whistling in the wind. We need fiscal policy and get this fiddling (while the economy burns) at the margins.