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Operation Twist: The Fed's plan to lower long-term interest rates

The U.S. Treasury Department in Washington, D.C. is seen on Aug. 8, 2011.

Meet "Operation Twist."

No, it's not a retro dance craze. It's the name people are giving the Federal Reserve's last best hope to help the economy.

We need consumers to buy stuff like cars and houses to keep the economy moving. To do that, consumers need to borrow. And one of the reasons they're not borrowing is because consumer loan interest rates are still too high.

Those loan rates are usually based on the price of long-term government debt, such as the 10-year Treasury note. The Fed's plan is to push those long-term benchmark rates lower.

The Fed already holds a lot of government debt, but much of it is short-term debt, the kind that companies use to fund their operations. Under Operation Twist, the Fed would sell its short-term treasury debt, and buy longer-term bonds instead. That increased demand for the long-term debt would push prices up, and therefore drive yields on debt like that 10-year T-note down. And as the 10-year falls, so interest rates on mortgages and car loans should fall also.

This sounds great in theory, but there are a number of big holes in the plan. Economist Karen Shaw Petrou told us the reason people aren't buying houses isn't because it's too expensive: rates are already at lows not seen since World War II.

It's because they're scared stiff. Either they don't have a job, or they're already too deep in debt. Or they're petrified about what will happen in the coming months. House prices falling even further? The death of the Euro? Another stock market meltdown?

Capitol Hill is still gridlocked - something that's unlikely to change in the wake of the President's jobs speech tomorrow - so people are looking to the Federal Reserve for action. Tomorrow Chairman Ben Bernanke speaks in Minneapolis and his words will be analyzed for any hints about what the Fed might or might not do. But most analysts expect that the Fed won't do anything until their two-day meeting later this month.


Also on the show, the Marketplace Daily Index is down 2 points today on news that the U.S. dropped another position in the World Economic Forum's annual competitiveness rankings. It's the third year in a row the U.S. has lost ground.

About the author

David Brancaccio is the host of Marketplace Morning Report. Follow David on Twitter @DavidBrancaccio

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