Operation Twist should aim to provide money in the hands of people, especially sectors which generate demand

March 10, 2020 1:40 AM

The quantitative easing is carried out using private and/or government bond purchases that have implications for overall yield, risk premia as well as real indicators.

cash, cash inflowThe Operation Twist in USA was envisioned under unconventional monetary policy.

By Surobhi Mukherjee

Unconventional monetary policies have been in use to give stimulus to advanced economies as conventional measures of monetary policies have cease to be effective or large fiscal stimulus has led to questions regarding unsustainability of debt. Post the financial crisis of 2007-08, the Federal Reserve System introduced the large scale asset purchase programme, Bank of Japan undertook comprehensive monetary easing from October 2010 (quantitative easing programme was also practised since March 2001), Bank of England introduced asset purchase programme since March 2009 and European Central Bank undertook long term refinancing operations since May 2009 as a part quantitative easing (QE).

The QE undertaken, resulted into central bank expansion of range of securities like outright purchase of asset-backed securities, exchange traded funds, gilt purchase mainly to facilitate smooth financing through adequate quantum of liquidity supply. These asset purchases under QE often have policy commitments tied to the economic indicators like CPI, IIP etc., and are aimed to compress the yield and risk premiums. Private demand for funds from the households and business is an important demand-side factor for revival of economy. The quantitative easing is carried out using private and/or government bond purchases that have implications for overall yield, risk premia as well as real indicators.

The Operation Twist in USA was envisioned under unconventional monetary policy. The US conducted this in 2011-12, and the plan included two components. First, simultaneous purchase and sale of treasuries. Second, reinvesting the principal payments from agency debt and agency mortgage-backed securities (MBS) into Agency MBS. RBI recently conducted it’s own version of Operation Twist with simultaneous sale and purchase of government securities to bring down longer-term interest rates. What does advanced countries experience has to offer?

Liquidity holding of household and business could be affected by such asset purchase as some of these(private purchase or government treasuries) allows credit-starved entrepreneurs to increase investment and households to demand more loans compared to others. A case in point is the US, wherein yield channel of transmission was envisaged to be less prominent in QE1 where Mortgage Backed Securities (MBS) were purchased largely compared to purchase of government treasuries in QE2. A meticulous study shows, under QE1, Fed purchased a large amount of Fannie Mae, Freddie Mac and Ginnie Mae securities and these provided liquidity to many banks, savings & loans, and mortgage companies that make loans to finance housing which increased availability of credit. The QE1 did boost housing market, but never led to higher output production as enough money didn’t go the households.

To put it in a nutshell, quantitative easing is not only concerned with quantity, but is also concerned with the composition of assets purchased by central banks. This is one of the important conclusions derived. In addition to this, for demand to revive and output to grow, money ought to be put in the hands of the people without neglecting capital adequacy of banks A second experience from Japanese Quantitative Easing Programme (QEP) in early 2000 gives a different exposure altogether.

Japanese Government Bonds were purchased during this QEP held in early 2000, but the overall yield did not fall consistently. This oddity could be explained by the huge general government debt to GDP ratio of Japan (the general govt debt in Japan was 176 times the GDP in 2006). It is to be emphasised here that Japan explicitly targeted prices and the impact of QEP on consumer price index was also muted. Fiscal slippages could be at odds with the intended motives of bringing down risk premiums, and, therefore, propelling investments and subsequently, growth.

The pedagogical learning from these antecedents is threefold and perhaps could be put into application. One, given that the transmission of rate cuts by RBI has been asymmetric, the purchase of long-dated and sale of short-dated government securities has the potential to reduce the spread between long- and short-term rates. Two, though debatable, operation twist should aim at providing money in the hands of people, especially the sectors where demand is generated, like government projects, and that could also boost investment for the private through linkage effect, like public transport and housing. Third, widening deficits of the government (including states) should be kept in check for the efficacy of long-term rate cuts to be maintained.

The writer IES, department of economic affairs, ministry of finance

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