The Transmission Mechanism and Effectiveness of the Fed's Operation Twist

The Fed’s Operation Twist (OT) is a variation of conventional open-market operations. However, as an unconventional monetary policy, its transmission mechanism and effectiveness need further exploration. In this paper, a macro-economic system is set up, which not only includes the central bank, commercial banks, and enterprises, but also covers a range of credit markets, bond markets and commodity markets. In order to analyze the transmission mechanisms of Operation Twist, the limit solution of nonhomogeneous linear equations is introduced. The impact of Operation Twist on the U.S. and world economies is studied quantitatively by selecting 24 non-equal frequency series of variables belonging to 7 categories: Treasury yield, quantity of loans of commercial banks, unemployment rate, inflation rate, GDP, exchange rate and trade. The TRAMO/SEATS technique is used to identify the structural change points of these series and make predictions. Results show that, in general, the effects of Operation Twist are not quiet ideal. Since Operation Twist is a policy designed to “fine-tune” the economy, the macroeconomic regulators should establish an organic system integrating monetary as well as fiscal policies, strengthening its coordination of interests between different nations so as to ensure better regulation on the macroeconomy.