United States: Fed replaces Operation Twist, ties monetary policy to unemployment rate
December 13, 2012
At its policy meeting on 11-12 December, the Federal Open Market Committee (FOMC) announced a new round of asset purchases that will replace its current average maturity extension programme - commonly referred to as Operation Twist - which is due to expire at the end of 2012. Under the new scheme, the Federal Reserve will purchase USD 45 billion of long-term Treasury securities starting January 2013. Combined with its current programme of agency mortgage-backed securities purchases, the Fed's holdings will increase by USD 85 billion per month, causing a sizable increase in the Federal Reserve's balance sheet.
The Fed also left the federal funds rate within the historically-low range of 0% to 0.25% established in December 2008, as expected by the market. However, in an unprecedented move, the Federal Reserve set a numerical threshold for unemployment and inflation as guidance for its monetary policy, stating that "this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6.5 percent", two-year inflation expectations do not exceed the Fed's 2.0% target by more than half a percentage point and long term inflation expectations remain well anchored.
The Federal Reserve justified its decision by stating that "these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative".
In its statement, the Fed explained that, although the unemployment rate has moderated recently, it still remains high, while adding that the housing sector is showing further signs of improvement. Regarding price developments, the Fed announced that inflation "has been running somewhat below the Committee's longer-run objective, apart from temporary variations that largely reflect fluctuations in energy price" while adding that long-term inflation expectations have remained stable. According to the Committee, inflation over the medium term will likely run "at or below its 2 percent objective".