eric t. swanson
Federal Reserve Bank of San Francisco
Let’s Twist Again: A High-Frequency Event-Study Analysis of Operation Twist and Its Implications for QE2
ABSTRACT This paper undertakes a modern event-study analysis of Operation Twist and uses its estimated effects to assess what should be expected for the recent policy of quantitative easing by the Federal Reserve, dubbed “QE2.” Thepaper first shows that Operation Twist and QE2 are similar in magnitude. It then identifies six significant, discrete announcements in the course of Operation Twist that could have had a major effect on financial markets and shows that four did have statistically significant effects. The cumulative effect of these six announcements on longer-term Treasury yields is highly statistically significantbut moderate, amounting to about 15 basis points (bp). This estimate is consistent both with time-series analysis undertaken not long after the event and with the lower end of empirical estimates of Treasury supply effects in the literature. The effects of Operation Twist on long-term agency and corporate bond yields are also statistically significant but smaller, about 13 bp for agencysecurities and 2 to 4 bp for corporates. Thus, the effects of Operation Twist seem to diminish substantially as one moves from Treasury securities toward private sector credit instruments.
n December 16, 2008, the Federal Reserve’s Federal Open Market Committee (FOMC) lowered the target for the interest rate on federal funds to essentially zero in response to the most severe U.S. financial crisis sincethe Great Depression. Since U.S. currency carries an interest rate of zero, it is virtually impossible for the FOMC to target a value for the federal funds rate that is substantially below zero. Faced with this zero lower bound, the FOMC in 2008 and 2009 endeavored to find alternative ways to stimulate the weak economy, such as by purchasing large quantities of mortgage-backed securities andlonger-term Treasury securities in
Copyright 2011, The Brookings Institution
Brookings Papers on Economic Activity, spring 2011
an effort to improve the functioning of those markets and reduce long-term interest rates.1 In late 2010, in response to continuing economic weakness and the zero lower bound, the FOMC embarked on a second round of quantitative policies, announcing itsintention to purchase “a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011.”2 This program has become known in the financial community and the financial press as QE2. The QE2 program has been controversial, with detractors conjecturing that the risks or costs of the policy are large while the benefits are small. For example, an open letter to FederalReserve Chairman Ben Bernanke, signed by several prominent economists and published in full-page ads in the Wall Street Journal and the New York Times, asserted that the purchases “risk currency debasement and inflation” and could “distort financial markets”; the signatories said further, “we do not think they will achieve the Fed’s objective of promoting employment” and that they are “neitherwarranted nor helpful in addressing either U.S. or global economic problems.”3 The present paper aims to estimate the potential benefits of QE2 by measuring the effect on long-term interest rates of Operation Twist, a very similar program undertaken by the Kennedy administration and the Federal Reserve in 1961. Although previous studies of Operation Twist using low-frequency (quarterly) data havegenerally found no significant effect of the program on long-term interest rates (see, for example, the exhaustive time-series analysis by Franco Modigliani and Richard Sutch 1966, 1967), the present paper undertakes a more modern, high-frequency event-study approach. The event-study methodology restricts attention to major announcements in the course of Operation Twist that can be pinpointed to a...
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