The Federal Reserve's Large-Scale Asset Purchase Programmes: Rationale and Effects

This 2012 Economic Journal paper by D’Amico, English, López-Salido, and Nelson estimates how the Federal Reserve’s large-scale asset purchase (LSAP) programmes of 2008-2011 lowered longer-term US Treasury yields, disaggregating the total effect into three transmission channels within a single unified empirical framework that nests all of them: an expectations/signalling channel (LSAPs convey information about the future path of short-term policy rates, operating purely through the expectations hypothesis of the term structure, with no imperfect asset substitution required); a scarcity (preferred-habitat) channel (a Fed purchase withdraws a specific maturity from private holders, creating excess demand that depresses yields at that maturity and nearby ones because investors do not substitute perfectly across maturities); and a duration channel (Fed purchases remove aggregate duration risk from the market, lowering term premiums more broadly across the maturity spectrum). Using weekly CUSIP-level (individual-security) US Treasury data from December 2002 to October 2008 — a pre-LSAP estimation window chosen specifically to avoid endogeneity that contaminates the LSAP period itself, since the Fed tended to buy securities precisely when yields were rising — the authors regress yields and term-premium components on the fraction of privately held nominal Treasuries in a given maturity bucket (PHNT) and an aggregate duration-risk gap measure (DG), finding both coefficients positive and statistically significant across maturities from 7 to 30 years (adjusted R-squared of 0.46-0.70), a result that survives controlling for Treasury option-implied volatility, a flight-to-quality proxy, and a business-conditions index. Applying these pre-crisis coefficients to the actual scale and maturity concentration of the LSAP programmes, the authors estimate the first LSAP ($300 billion, concentrated in the 2-10 year sector) lowered longer-term Treasury yields by roughly 35 basis points (about 23bp from the scarcity channel plus 12bp from the duration channel), and the second LSAP ($600 billion) by roughly 45 basis points (about 35bp scarcity plus 10bp duration) — equivalent, using a standard rule-of-thumb conversion, to federal-funds-rate cuts of about 140 and 180 basis points respectively. A supporting intraday event study of the August 10, 2010 FOMC/FRBNY reinvestment announcement, together with the finding that scarcity and duration coefficients remain significant when controlling for proxies of expected short-rate paths, leads the authors to state that their results suggest LSAPs do not operate solely or even primarily via the expectations channel, and that preferred-habitat elements are a necessary ingredient for understanding monetary transmission to long-term rates even away from the zero lower bound (their pre-LSAP sample predates the ZLB period). The scope of the quantitative results is explicitly limited to nominal Treasury securities — the paper does not directly quantify the effects of the agency debt and MBS purchased in the first LSAP round — and rests on extrapolating relationships estimated in a short, pre-crisis, non-LSAP sample to the LSAP period, a limitation the authors themselves flag.

William English | Macro Paper Warehouse

The Federal Reserve's Large-Scale Asset Purchase Programmes: Rationale and Effects