Federal Reserve Does the 'Twist' to Fix Economy, But Results Uncertain

The Fed is altering its balance sheet to encourage growth, but major barriers to recovery remain

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No surprises from the Federal Reserve today. And, perhaps, few results.

Today the Federal Open Markets Committee fulfilled expectations and announced what is being called "Operation Twist"—a move in which the Fed extends the average maturity of its balance sheet. Acknowledging broad economic weaknesses, the committee reported that it intends to sell off $400 billion in treasury securities with remaining maturities of 3 years or less and purchase an equal amount of securities with remaining maturities of 6 to 30 years. The Committee also reaffirmed its pledge to maintain a low federal funds rate through mid-2013.

[See how the president's deficit-reduction plan could backfire]

The committee's decision represents another attempt to shore up the economy even as President Obama and the Congress are unable to agree on policies to promote economic recovery.

The idea behind "Operation Twist" is to push longer-term rates down and, hopefully, encourage mortgage borrowing and lending to businesses. But low interest rates have been in place since 2008 and have not thus far significantly spurred lending. While "Twist" could help in the refinancing arena, other major barriers to growth remain, writes Joel Naroff, president and chief economist of Naroff Economic Advisors, in a commentary released today: "[B]usinesses are flush with cash already and it isn't rates that are stopping them from hiring or investing more. Companies are just uncertain about the direction of the economy and demand is not growing fast enough to require greater job growth." [Check out editorial cartoons about the economy.]

Frank Fantozzi, CEO for Planned Financial Services, believes that the "twist" policy simply doesn't have the muscle to create real change in the nation's economic fortunes: "I think it's a good thing, but in and of itself is not going to be enough," he says, but he adds that political uncertainty needs to be addressed alongside economic uncertainty. "I think the bigger problem that is in the way of the Fed, in the way of the economy, is a lack of clear leadership and clear policy," Fantozzi says.

Since the start of the economic crisis, the Fed has already pledged near-zero interest rates well into 2013, undertaken two rounds of quantitative easing, and now set into motion Operation Twist. This raises the question of what more the Fed can do.

Robert Tipp, chief investment strategist for Prudential Fixed Income, points out that of the committee's 10 voting members, three voted against this week's decision, "so clearly some on the Fed itself think they are out of tools."

[See 5 political lessons of the economic downturn.]

According to Fantozzi, one thing the Fed can't do is go it alone; policymakers need to step up as well in order to turn around the largest economy in the world. "There's no one silver bullet that makes everything right. It's usually an accumulation of good, smart policymaking decisions that turn the ship. ... You're not going to steer it like a speedboat. The big thing that has to come next is the jobs bill. There needs to be some partisan agreement on what's going to happen."

[See a slide show on the many faces of Ben Bernanke.]

Given the Republican backlash to both the president's jobs plan and subsequent deficit-reduction proposal, that partisan agreement appears unlikely. Indeed, even the independent Fed was pulled into the political arena this week, when Republican congressional leaders sent Chairman Ben Bernanke a letter advising that the Federal Reserve "resist further extraordinary interventions in the U.S. economy." Given continued weakness in the housing market, turmoil in Europe, ever-slowing job growth, and political uncertainty, one can only hope that Bernanke will have that luxury.