Impact of Operation Twist on the Economy

Impact of Operation Twist on the Economy

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Under Operation Twist, when the RBI purchases long-term bonds, the long-term interest rate will decrease. Because of the low interest rate, households and businesses will be more likely to take out long-term loans for purchases and investments, which will boost economic activity. In contrast, when the RBI sells short-term government securities, their yield increases and the price of the securities decreases. In practice, the RBI sold short-term securities and purchased long-term securities. Because of this, the short-term loan interest rate will rise, while the long-term loan interest rate will decrease.

The yield of securities is affected by the RBI's selling and buying. Due to RBI buying, the price of a government security goes up when there is a lot of demand for it. Imagine that a ten-year bond cost Rs 1000 at first, with a 10% interest rate equal to Rs 100. Let's say that the RBI is buying a lot of 10-year government bonds, which is why there is a lot of demand for them. Demand for them rises, and their price in the secondary market for bonds rises to Rs 1200 as a result of the high level of RBI borrowing. People are willing to sell the bond at a higher price because of the high demand. In this case, a bond worth Rs 1000 goes up to Rs 1200 on the secondary market. The secondary market is where bonds, like shares, can be sold and bought.

Nonetheless, a purchaser of a 10-year bond pays Rs 100 in interest because the initial interest rate was 10% (of Rs 1000). The bond's new owner paid Rs. 1200 for it, but he only gets Rs. 100 in interest (the bond's interest rate or yield). In other words, 8.3% is Rs 100 for a Rs 1200 investment. 10% as the initial interest rate; however, on the lookout for that security, the cost expanded, yet yield diminished. The initial interest rate (yield) of 10% is higher than this yield of 8.3%. As a result, the yield of the RBI's purchases of government securities drops here.

The yield on long-term securities decreases if the RBI purchases long-term bonds. This will have an impact on the entire economy. due to the fact that a number of institutions charge loan interest rates based on the yield of government securities. When it comes to determining interest rates, other institutions use government securities as financial benchmarks. Banks will lower the interest rates on their long-term loans if the yield on long-term securities decreases. As a result, a warning to the entire financial system is the falling yield on government securities. In a similar vein, the corporation will also have to pay less interest on their long-term bonds.