-Replace $45 Billion Operation Twist With $25 Billion Outright Treasury Buys

By Steven K. Beckner

LITTLE ROCK (MNI) – St. Louis Federal Reserve Bank President James Bullard
Monday said that, when it comes to replacing the expiring $45 billion monthly
Treasury bond purchases under “Operation Twist,” the Fed should not go the route
of increasing outright purchases of mortgage-backed securities.

He said it should replace the Twist purchases with outright purchases of
long-term Treasury securities, but not on a one-for-one basis. He estimated that
about a $25 billion monthly pace of Treasury purchases would keep monetary
policy “on an even keel.”

Fully replacing the $45 billion monthly Twist Treasury purchases would
cause monetary policy to be “more accommodative,” and he said that is not
necessary because the economic outlook “hasn’t changed that much.”

Although he is “concerned” about recent economic slowing, Bullard said he
has not changed his forecast of 3.5% real GDP growth next year.

At their Dec. 11-12 FOMC meeting, Fed policymakers will be deciding how
much and what type of assets to purchase in 2013. The Fed’s Operation Twist
expires on Dec. 31.

If nothing is done by the FOMC, aggregate Fed asset purchases will shrink
from $85 billion per month to $40 billion per month — the amount of mortgage
backed securities the Fed is buying under the third round of “quantitative
easing.”

Under Bullard’s proposal, total asset purchases would shrink from $85
billion to $65 billion, but he said that would not change the net monetary
impact.

Bullard contended that outright purchases of long-term Treasuries would be
“more potent” than Twist purchases, because they are financed by the creation of
new reserves and do not take short-term Treasuries off the market.

And so he said it would not be appropriate to keep buying $45 billion of
Treasuries per month next year. “We could maintain the current stance with about
$25 billion” of Treasury purchases, he said.

Bullard said the sensible thing for the FOMC to do is “to keep policy on an
even keel.” To replace Twist dollar-for-dollar with outright purchases “would
make it a little more dovish.”

“$25 billon in outright purchases would keep it on an even keel,” he went
on, adding that “the goal here should be to keep policy unchanged.”

Asked by MNI whether he would support replacing the Twist Treasury
purchases in part with MBS purchases, Bullard noted that the Fed is “already
purchasing $40 billion in MBS,” and so “it would probably be wise at this point
to go to Treasuries.”

Bullard said he “would really prefer Treasuries to MBS,” because buying
Treasuries lowers interest rates in all markets, not just the housing finance
market.

Besides, he said, “it would be hard to do more than $40 billion of MBS”
without “impairing market function.”

By contrast, Boston Fed President Eric Rosengren earlier supported
increased MBS purchases. He too will be an FOMC voter next year.

Following up on prepared remarks in which he spoke in favor of replacing
the mid-2015 date for raising the federal funds rate with a set of economic
thresholds, Bullard said he would prefer to use “qualitative” guidelines rather
than a “quantitative” approach.

But he said he could support numerical thresholds, such as a 6.5%
unemployment rate, if various problems could be worked out.

Bullard said that inflation running below the Fed’s target if 2% gives the
Fed “room to adjust” monetary policy, but said “we already did that” in
launching a third round of quantitative easing in September.

Earlier, in response to audience questions, Bullard said the so-called
“fiscal cliff,” if not avoided, would have economic effects too large for the
Fed to offset through monetary stimulus.

Bullard, who will be a voting member of the FOMC next year, said he does
not disagree with the Congressional Budget Office’s very negative assessment of
the impact of the automatic tax hikes and spending cuts, known as the “fiscal
cliff,” due to hit on Jan. 1.

“I’m happy to go with the CBO analysis which says that, at least in the
near term, the U.S. would suffer a pretty significant hit on GDP,” he said in
response to audience questions following a speech to the Little Rock Chamber of
Commerce.

“And it would take a while for the U.S. economy to adjust to that
situation,” he said.

Bullard added that “that kind of shock would be too large for U.S. monetary
policymakers to react to in a way that would offset the effect of the fiscal
cliff.”

Asked about China, he said that rapidly growing economy is becoming
increasingly important to the world economy and, hence, to monetary policy
deliberations.

But he said it has “a long way to go,” for example in terms of making its
currency convertible.

** MNI **

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