What is Operation Twist?

The Reserve Bank of India follows many monetary policies to control the money supply and interest rates in the Economy. These include reserve requirements, discount rates, interest on reserves, and open Market operations. Among these, Open Market operations are the purchase and sale of securities from the open market by the central bank to either increase or decrease the money supply and the interest rates. Operation twist is a policy under the Open Market Operations of the central bank.

It is the simultaneous purchase of long-term securities and sale of short-term securities by the RBI. As a result of the operation twist, the long-term yield rate (interest rate) falls, and the short-term yield rate rises. This leads to a twist in the shape of the yield curve. Hence, it is called operation ‘twist’.

Origin Of Operation Twist

The US economy was in Recession in 1961, still recovering from the effects of the Korean war. All the other monetary policies had failed. Thus, the Federal Open Market Committee (FOMC) developed the aim to strengthen the weakening US economy by strengthening the value of the US Dollar and inducing money supply in their economy. The FOMC bought short-term securities from the market, thus flattening the short-term yield curve. Then they used the proceeds from this sale to buy long-term securities, leading to a rise in the long-term yield curve.

How does Operation Twist Works?

When an economy is weakening, when there is a lack of money supply in the economy, or when there is economic depression, the mechanism of operation twist helps in reviving such a situation. When the central bank buys long-term securities, it increases the money supply in the economy, and thus, people have more money to invest elsewhere.

Apart from increasing the money supply, this move also decreases the interest rate on long-term borrowings. This enables people to obtain credit for purchasing homes, cars, financing various projects, and other long-term investments. Alternatively, because of the sale of short-term securities by the central bank, the short-term interest rates rise, discouraging people from Investing in the short term. During the pandemic, the RBI carried out operation twists in a series of three events of buying and selling. Since the pandemic had led to Inflation and unemployment, the RBI had the sole objective to solve these two major economic issues.

Importance

A weakening economy is one where the growth is slow or negligible due to low rates of economic activity. The result of the operation twist is the induction of money in the economy and lower long-term borrowing rates. Both of these things encourage people to invest in long-term projects, which in turn induces economic activity, and the economy can be brought back to normal.

Operation Twist Example

This can be better understood with an example:

Suppose a central bank undertakes the monetary policy of operation twist. Now, the people have more money with them, plus they are keen on taking long-term credit for, say, investing in housing projects or simply buying houses.

Now, this will create new demand for houses, which in turn will compel builders to build more houses. This process will also generate employment because the construction of houses needs labour. Moreover, the construction will also require Raw Materials, which in turn will create a demand for cement, bricks, etc. The producers of this raw material will start their production. This will again create employment. Therefore, this way, the weakened economy will come back on track.

Conclusion

The central bank of an economy tries to revive the sluggish economy using various monetary policies. But where other policies Fail, operation twist succeeds in bringing the desired results. The sole objective of operation twist is to encourage people to invest long-term by increasing the money supply in the economy and providing lower rates of long-term borrowing.