(2) In 2012, the Federal Reserve performed an unusual monetary policy move calle
ID: 1226827 • Letter: #
Question
(2) In 2012, the Federal Reserve performed an unusual monetary policy move called “Operation Twist”. In this move, the Federal Reserve sold some of their existing holdings of Treasury Bills (on the secondary market) in order to buy Treasury Bonds.
(c) Name one other change – including the correct direction of change -- that would generate that same looking graph (in the overall bond market) as Treasury Bonds in the above question (1 point).
(d) Provide an example of a bond with similar maturity as Treasury Bills and explain how its interest rate will change as a result of “Operation Twist”. Briefly justify your answer (you don’t have to provide a graph) (3 points).
Explanation / Answer
2) Federal reserve enters open market operations now and then to create liquidity or curb liquidity.
The latest operation is really a twisted one,
The federal reserve benchmark lending rates were close to zero since financial crisis, This has created a unqiue situation of sluggishness in the economy, The rate cuts had no impact on the economy for two reasons
Banks were already strained and they were unwilling to lend
Fed has no mechanism for direct dealing with market without involving banks
This has resulted in sluggishness and exposed limits of fed to the market.
After this entire episode, They wanted to sell bonds which are issued at lower intrest rates and buy bonds that might now be issued at higher intrest rates. They were offloading some old stock. This is not to create liquidity but to save themselves.
New bonds must be issued by government at higher intrest rate after fed intrest hike, yield must be made higher to make them attractive, That is what government do.
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