I was rummaging through some CNBC videos this evening and came across this interview with Deutsche Bank’s Chief US Economist, Joe Lavorgna and CNBC’s Steve Liesman (see below). The interview is interesting for a few reasons. First, we have Lavorgna saying that Operation Twist is not going to do anything (which is right) and then we have Steve Liesman jumping in to argue that it could move interest rates as much as “10-20 basis points”. Lavorgna then jumps in to correct him by (correctly) arguing that 10-20 bps is “noise” even if it does do anything (which it won’t). But then they both essentially go on to agree that the Fed should do something just for the sake of doing something. Basically, they don’t want to disappoint markets so it’s better just to make it look like you’re doing something rather than do nothing at all. This is the sad state of monetary policy these days where we implement policy not because it’s going to do something, but because we want to give the appearance of trying….It would be hilarious if it wasn’t so misguided.
Lavorgna goes on to argue that there will be a cost to Operation Twist by saying that it will make their portfolio longer duration and force the Fed to take capital losses on their portfolio when they are forced to sell the portfolio to ease policy. But this is just not correct. As the NY Fed explained when QE was first implemented, the payment of reserves now serves as a de facto Fed Funds Rate and helps support the overnight market. In other words, there is no need to sell off the portfolio if the Fed wants to tighten interest rates. All they would do is raise the rate on reserves (via the NY Fed):
“The Open Market Trading Desk (Desk) at the Federal Reserve Bank of New York is authorized to arrange open market operations in accordance with the operating directive of the Federal Open Market Committee (FOMC), which sets a target for the federal funds rate. Without authority to pay interest on reserves, from time to time the Desk has been unable to prevent the federal funds rate from falling to very low levels. With the payment of interest on excess balances, market participants will have little incentive for arranging federal funds transactions at rates below the rate paid on excess. By helping set a floor on market rates in this way, payment of interest on excess balances will enhance the Desk’s ability to keep the federal funds rate around the target for the federal funds rate.“
So, I am not sure what’s worse here – the level of misunderstanding that still persists around basic monetary operations (at the very highest levels) or the fact that we’re implementing policy now just to give the appearance that we’re trying something….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.