Large‐Scale Asset Purchases by the Federal Reserve:
Did They Work?
Joseph Gagnon, Matthew Raskin, Julie Remache, and Brian Sack1
March 2010

ABSTRACT
Since December 2008, the Federal Reserve’s traditional policy instrument, thetarget federal funds rate, has been effectively at its lower bound of zero. In orderto further ease the stance of monetary policy as the economic outlook
deteriorated, the Federal Reserve purchased substantial quantities of assets withmedium and long maturities. In this paper, we explain how these purchases were
implemented and discuss the mechanisms through which they can affect theeconomy. We present evidence that the purchases led to economicallymeaningful and long-lasting reductions in longer-term interest rates on a range of
securities, including securities that were not included in the purchase programs.
These reductions in interest rates primarily reflect lower risk premiums, including
term premiums, rather than lower expectations of future short-term interest rates.

1

Joseph Gagnon is a senior fellow at the Peterson Institute for International Economics. Matthew Raskin is an
economic analyst and Julie Remache is a supervisor in the Markets Group of the Federal Reserve Bank of New
York. Brian Sack is executive vice president and head of the Markets Group of the Federal Reserve Bank of New
York, and manages the System Open Market Account for the FOMC. The authors thank Seamus Brown, Mark
Cabana, Michelle Ezer, Michael Fleming, Jeremy Forster, Joshua Frost, Allen Harvey, Spence Hilton, Warren
Hrung, Frank Keane, Karin Kimbrough, David Lucca, Brian Madigan, Patricia Mosser, Asani Sarkar, Lisa Stowe,
Richard Wagreich, Carl Walsh, and Jonathan Wright for helpful comments, Clara Sheets for valuable research
assistance, and Carol Bertaut for guidance on the foreign official holdings data. The views expressed are those of
the authors and do not necessarily reflect the positions of the Peterson Institute, the Federal Reserve Bank of New
York, or the Federal Reserve System.

1. Introduction
In December 2008, the Federal Open Market Committee (FOMC) lowered the target for
the federal funds rate to a range of 0 to 25 basis points. With its traditional policy instrument set
as low as possible, the Federal Reserve faced the challenge of how to further ease the stance ofmonetary policy as the economic outlook deteriorated. The Federal Reserve met this challengein part by purchasing substantial quantities of assets with medium and long maturities in aneffort to drive down private borrowing rates, particularly at longer maturities. These large-scaleasset purchases (LSAPs) have greatly increased the size of the Federal Reserve’s balance sheet,and the additional assets may remain in place for years to come.
To be sure, the Federal Reserve undertook other important initiatives to combat thefinancial crisis. It launched a number of facilities to relieve financial strains at specific types of
institutions and in specific markets. In addition, to provide even more stimulus, it used public
communications about its policy intentions to lower market expectations of the federal funds ratein the future. All of these strategies were designed to ease financial conditions and support asustained economic recovery. Over time, though, the credit extended by the liquidity facilities
has declined and the dominant component of the Federal Reserve’s balance sheet has become theassets accumulated under the LSAP programs.
The decision to purchase large volumes of assets came in two steps. In November 2008,
the Federal Reserve announced purchases of housing agency debt and agency mortgage-backed
securities (MBS) of up to $600 billion. In March 2009, the FOMC decided to substantiallyexpand its purchases of agency-related securities and to purchase longer-term Treasury securities
as well, with total asset purchases of up to $1.75 trillion, an amount twice the magnitude of total

-2Federal Reserve assets prior to 2008.2 The FOMC stated that the increased purchases of agencyrelated securities should “provide greater support to mortgage lending and housing markets” andthat purchases of longer-term Treasury securities should “help improve conditions in private
credit markets.”
In this paper, we review the Federal Reserve’s experience with implementing the LSAPs
and describe some of the challenges raised by such large purchases in a relatively short time. In
addition, we discuss the economic mechanisms through which LSAPs may be expected tostimulate the economy and present some empirical evidence on those effects. In particular,
LSAPs reduce the supply to the private sector of assets with long duration (and, in the case ofmortgage securities, highly negative convexity) and increase the supply of assets (bank reserves)
with zero duration and convexity.3 To the extent that private investors do not view these assets
as perfect substitutes, the reduction in supply of the riskier longer-term assets reduces the risk
premiums required to hold them and thus reduces their yields. We assess the extent to which
LSAPs had the desired effects on market interest rates using two different approaches and findthat LSAPs caused economically meaningful and long-lasting reductions in longer-term interest
rates on a range of securities, including on securities that were not included in the purchaseprograms. We show that these reductions in interest rates primarily reflect lower risk premiums
rather than lower expectations of future short-term interest rates.4 We conclude with a
discussion of issues raised by these policies and potential lessons for implementing monetary

2

The Treasury Department also established a program to purchase agency MBS beginning in September 2008. Asof year-end 2009 it had purchased $220 billion of such securities. This program is much smaller than the Federal
Reserve LSAPs and no specific purchase amount targets were announced, so it is not included in our analysis below.
3
Negative convexity arises from the ability of mortgage borrowers to prepay their loans. As interest rates fall, theincentive to prepay increases, generally resulting in an increase in prepayments to MBS holders. This effect causes
the duration of MBS to fall as interest rates decline and vice versa. This is explained in more detail in the next
section.
4
As we discuss below, these risk premiums, or excess expected returns, arise due to interest rate, credit, or liquidity
risk, or other characteristics that make the assets’ returns uncertain.

-3policy at the zero bound in the future.

2. How Large-Scale Asset Purchases (LSAPs) Affect the Economy
The primary channel through which LSAPs appear to work is by affecting the risk
premium on the asset being purchased. By purchasing a particular asset, the Federal Reserve
reduces the amount of the security that the private sector holds, displacing some investors andreducing the holdings of others, while simultaneously increasing the amount of short-term, riskfree bank reserves held by the private sector. In order for investors to be willing to make thoseadjustments, the expected return on the purchased security has to fall. Put differently, thepurchases bid up the price of the asset and hence lower its yield. This pattern was described by
Tobin (1958) and is commonly known as the “portfolio balance” effect.5
Note that the portfolio balance effect has nothing to do with the expected path of shortterm interest rates. Longer-term yields can be parsed into two components: the average level ofshort-term risk-free interest rates expected over the term to maturity of the asset and the risk
premium. The former represents the expected return that investors could earn by rolling overshort-term risk-free investments, and the latter is the expected additional return that investors
demand for holding the risk associated with the longer-term asset. In theory, the effects of the
LSAPs on longer-term interest rates could arise by influencing either of these two components.
However, the LSAPs have not been used as a signal that the future path of short-term risk-freeinterest rates would remain low.6 In fact, at the same time that the Federal Reserve was
5

There is a large body of literature on consumer optimizing models of portfolio selection, which are variants of theportfolio balance model that impose restrictions arising from the assumed utility functions of investors. See
Markowitz (1952), Sharpe (1964), and Campbell and Viceira (2001, 2005).
6
Indeed, the FOMC instead directly used language in its statements to signal that it anticipates that short-term
interest rates will remain exceptionally low for an extended period. However, as discussed below, neither the
language about future policy rates in the FOMC statements nor the LSAP announcements appear to have had asubstantial effect on the expected future federal funds rate.

-4expanding its balance sheet through the LSAPs, it was going to great lengths to inform investors
that it would still be able to raise short-term interest rates at the appropriate time. Thus, any
reduction in longer-term yields instead has likely come through a narrowing in risk premiums.
For Treasury securities, the most important component of the risk premium is referred toas the “term premium,” and it reflects the reluctance of investors to bear the interest rate risk
associated with holding an asset that has a long duration. The term premium is the additional
return investors require, over and above the average of expected future short-term interest rates,
for accepting a fixed, long-term yield. The LSAPs have removed a considerable amount ofassets with high duration from the markets. With less duration risk to hold in the aggregate, themarket should require a lower premium to hold that risk. This effect may arise because thoseinvestors most willing to bear the risk are the ones left holding it.7 Or, even if investors do notdiffer greatly in their attitudes toward duration risk, they may require lower compensation forholding duration risk when they have smaller amounts of it in their portfolios.
In addition to the effect of removing duration and hence shrinking the term premium
across all asset classes, Federal Reserve purchases of agency debt and agency MBS might be
expected to have an additional effect on the yields on those assets through other elements of theirrisk premiums. For example, these assets may be seen as having greater credit or liquidity risk
than Treasury securities.8 In addition, the purchases of MBS reduce the amount of prepayment
risk that investors have to hold in the aggregate. Prepayment risk on MBS causes the duration of
MBS to shrink when interest rates decline and rise when interest rates increase. These changes
7

Indeed, in the preferred-habitat model of Modigliani and Sutch (1966) it is possible that some agents seek to holdlong-duration assets, e.g. for retirement, so that the term premium can, in principle, be negative.
8
Prior to December 2009, the Treasury had committed to sizable but limited capital injections in the housing
agencies, and thus had not issued a blanket guarantee of agency obligations. On December 24, 2009, the Treasury
removed the limit on capital injections over the next three years, stating that it wished to “leave no uncertainty about
the Treasury’s commitment to support these firms.” Agency debt and agency MBS are not as liquid as Treasury
securities. The direct effect of LSAPs on liquidity of these securities is considered further below.

-5in duration imply that MBS have negative convexity: compared to the price of a non-callable
bond with the same coupon and maturity, MBS prices rise less when rates fall and decline morewhen rates rise. Given this undesirable profile and the cost of hedging against it, investors
typically demand an extra return to bear the negative convexity risk, keeping MBS rates higher
than they would otherwise be. The LSAPs removed a considerable amount of assets with highconvexity risk, which would be expected to reduce MBS yields.
These portfolio balance effects should not only reduce longer-term yields on the assets
being purchased, but should also spill over into the yields on other assets. The reason is thatinvestors view different assets as substitutes and, in response to changes in the relative rates ofreturn, will attempt to buy more of the assets with higher relative returns. In this case, lower
prospective returns on agency debt, agency MBS, and Treasury securities should cause investors
to seek to shift some of their portfolios into other assets such as corporate bonds and equities andthus should bid up their prices. It is through the broad array of all asset prices that the LSAPs
would be expected to provide stimulus to economic activity. Many private borrowers would findtheir longer-term borrowing costs lower than they would otherwise be, and the value of longterm assets held by households and firms, and thus aggregate wealth, would be higher.
The effects described so far would be caused by LSAP-induced changes in the stock ofassets that is held by the public. Moreover, to the extent that investors care about expected
future returns on their assets, today’s asset prices should reflect expectations about the future
stock of assets. Thus, a credible announcement that the Federal Reserve will purchase longerterm assets at a future date should reduce longer-term interest rates immediately. Otherwise,
investors could make excess profits by buying the assets today to sell to the Federal Reserve inthe future.

-6There may also be effects on the prices of longer-term assets if the presence of theFederal Reserve as a consistent and significant buyer in the market enhances market functioning
and liquidity. The LSAP programs began at a point of significant market strains, and the poor
liquidity of some assets weighed on their prices. By providing an ongoing source of demand for
longer-term assets, the LSAPs may have allowed dealers and other investors to take larger
positions in these securities or to make markets in them more actively, knowing that they could
sell the assets if needed to the Federal Reserve. Such improved trading opportunities could
reduce the liquidity risk premiums embedded in asset prices, thereby lowering their yields.9
This liquidity, or market functioning, channel, which is distinct from the portfolio
balance channel, appears to have been important in the early stages of the LSAP programs forcertain types of assets. For example, the LSAP programs began at a point when the spreads
between yields on agency-related securities and yields on Treasury securities were well above
historical norms, even after adjusting for the convexity risk in MBS associated with the highinterest rate volatility at that time. These spreads in part reflected poor liquidity and elevatedliquidity risk premiums on these securities.10 The flow of Federal Reserve purchases may havehelped to restore liquidity in these markets and reduced the liquidity risk of holding thosesecurities, thereby narrowing the spreads of yields on agency debt and MBS to yields on
Treasury securities and reducing the cost of financing agency-related securities.
Another example is older Treasury securities, which had become unusually cheap relative
to more recently issued Treasury securities with comparable maturities. Such differences would

9

It is possible that the flow of purchases may affect longer-term interest rates for reasons other than the effects onmarket functioning and liquidity, if the market faces other frictions.
10
Another contributing factor to the high yield spreads is that many financial firms at that time faced constraints on
their balance sheets, given the large capital losses on other assets and limited access to new funds. Capitalconstraints put agency-related debt at a disadvantage relative to Treasury securities, as agency-related holdings havea 20 percent risk weighting compared to 0 percent for Treasury securities.

-7normally be arbitraged away, but investors and dealers were reluctant to buy the older securities
because their poor liquidity meant that they might be difficult to sell. However, once the Federal
Reserve began buying such bonds, investors and dealers became more willing to hold them, andthe yield spreads narrowed to normal levels.
Overall, LSAPs may affect market interest rates through a combination of portfolio
balance and market functioning effects. Although the effects on market functioning were quite
important at the start of the LSAPs, the primary effects today are likely associated with theportfolio balance effect, now that financial strains have receded. In such circumstances, thewinding down of LSAPs need not cause a meaningful rise in market interest rates as long as thecompletion of purchases is announced well in advance. Indeed, the completion of the longerterm Treasury purchases in late 2009 and the slowing of the agency debt and agency MBS
purchases in late 2009 and early 2010 do not appear to have had significant effects on interest
rates.
3. Implementation of LSAPs
The Federal Reserve holds assets that it has purchased in the open market in its System
Open Market Account (SOMA). Historically, SOMA holdings have been nearly all Treasury
securities, although small amounts of agency debt were held at times in the past.11 Purchases andsales of SOMA assets are called outright open market operations (OMOs). Outright OMOs, inconjunction with repurchase agreements and reverse repurchase agreements, traditionally wereused to alter the supply of bank reserves in order to influence conditions in the federal funds

11

Agency purchases were introduced in 1971 in order to "widen the base for System open market operations and to
add breadth to the market for agency securities." New purchases were stopped in 1981, although some maturing
funds from agency holdings were reinvested in newly issued agency securities. Beginning in 1997, all holdings ofagency securities were allowed to mature without replacement. The last agency holding acquired under these
programs matured in December 2003.

-8market.12 Most of the higher-frequency adjustments to reserve supply were accomplishedthrough repurchase and reverse repurchase agreements, with outright OMOs conductedperiodically to accommodate trend growth in reserve demand.
OMOs generally were designed to have a minimal effect on the prices of the securities
included in the operations. To that end, they tended to be small in relation to the markets for
Treasury bills and Treasury coupon securities. LSAPs, on the other hand, aimed to have a
noticeable impact on the interest rates of the assets being purchased as well as on other assets
with similar characteristics. In order to achieve this goal, LSAPs were designed to be large
relative to the markets for these assets. Between December 2008 and March 2010, the Federal
Reserve will have purchased more than $1.7 trillion in assets. This represents 22 percent of the$7.7 trillion stock of longer-term agency debt, fixed-rate agency MBS, and Treasury securities
outstanding at the beginning of the LSAPs.13 Another way to scale the purchases is to measure
the amount of duration they removed from the market using the concept of “10-year
equivalents”, or the amount of 10-year par Treasury securities that would have the same duration
as the portfolio of assets purchased. Between December 2008 and March 2010, the Federal
Reserve will have purchased about $850 billion in 10-year equivalents. That represents morethan 20 percent of the $3.7 trillion outstanding stock of 10-year equivalents across these three

12

A repurchase agreement is similar to a collateralized loan. The borrower sells a security to the lender andsimultaneously promises to buy back the security at a fixed price. The Federal Reserve lends funds to the market
through repurchase agreements in order to increase reserves. To withdraw funds, the Federal Reserve engages in
repurchase agreements in the opposite direction, also known as “reverse repurchase agreements.”
13
The outstanding stock is computed from Barclay’s Capital Indices, based on data for November 24, 2008 (the day
before the initial announcement of LSAPs). The amount includes only fixed-rate issues with at least one year to
final maturity, and at least $250 million par amount outstanding. The measure of agency debt outstanding includes
debt issued by U.S. government agencies, quasi-federal corporations, and corporate or foreign debt guaranteed by
the U.S. government (such as USAID securities), but the largest issues are from Fannie Mae, Freddie Mac, and theFederal Home Loan Bank System.

-9asset classes at the beginning of the programs.14,15 We believe that no investor--public or
private--has ever accumulated such a large amount of securities in such a short period of time.
As with all OMOs, the implementation of LSAP programs was carried out by the Federal
Reserve Bank of New York (New York Fed) under delegated authority from the FOMC to the
SOMA Manager at the New York Fed. Under this authority, the SOMA Manager is responsible
for the design and execution of OMOs to achieve the policy mandate set forth by the FOMC.
Among the challenges in implementing OMOs for the LSAP programs was the need tocommunicate clearly to market participants the Federal Reserve’s goals and strategy for LSAPs
and to execute such large purchases while maintaining healthy market functioning.
Purchases of MBS posed the greatest operational challenge, owing to the more complex
nature and heterogeneity of these securities and to the size of the MBS purchase program.
Although the New York Fed had routinely accepted agency MBS as collateral in repurchaseagreement transactions, these securities previously had not been purchased on an outright basis.
In order to quickly and efficiently implement the MBS purchases and to mitigate financial andoperational risk, the New York Fed hired external investment managers to execute thesepurchases.16 Working closely with staff at the New York Fed on a day-to-day basis, theinvestment managers executed a certain quantity of purchases on behalf of the Federal Reserve

14

The outstanding stock of 10-year equivalents is also computed from Barclay’s Capital Indices, based on data for
November 24, 2008. Note that this measure of duration is affected by changes in the shape of the Treasury yield
curve, and by the level of interest rates through their effect on prepayment of MBS.
15
Note that, in these calculations, we combine the purchases of all three asset types, as they all remove durationfrom the market and hence should affect risk premiums on all assets with duration exposure. In the regression
analysis in Section 4, we focus on the net supply of long-term assets by the public sector because this measureplausibly may be assumed to be exogenous with respect to risk premiums. We thus ignore privately issued longterm assets that are held by private investors.
16
Four investment firms were hired to provide trading and advisory services at the start of the program: BlackRock,Goldman Sachs Asset Management, PIMCO, and Wellington Management Company. On August 17, 2009, the
New York Fed announced that Wellington Management Company would become the sole investment manager andthat BlackRock would be retained for analytical support services. JPMorgan was hired as the programadministrative agent and custodian.

- 10 across a range of actively traded securities in the market each day. Those transactions werecarried out with the Federal Reserve’s primary dealers as the counterparties.17
Purchases of agency debt and Treasury securities posed less of a challenge, as thesesecurities were already handled by the New York Fed in traditional OMOs. Unlike MBS
purchases, the agency and Treasury purchases were arranged as multi-price reverse auctions
conducted over the Federal Reserve’s proprietary trading system, FedTrade.18 The auctions
provided a mechanism through which primary dealer counterparties could indicate the prices andquantities which they were willing to sell, facilitating competition between auction participantsand enabling a market-based determination of purchases. Overall, the New York Fed conducted
60 operations for purchasing Treasury securities, or an average of nearly two per week over thecourse of the program; for agency securities, the number of operations through January 2010
totaled 62, or about one per week.19 Each operation focused on a particular maturity segment of
securities and, to the extent possible, was scheduled to avoid conflicting with other operations ormarket events, such as Treasury debt auctions, agency offerings, and significant planned
economic news releases. A summary of purchases was published on the New York Fed’s
website following each operation.20
For each of the three types of assets included in the LSAPs, the SOMA Manager, in
consultation with the FOMC, designed a strategy for the pace and composition of purchases.

17

Weekly summaries of MBS purchases can be found at http://www.newyorkfed.org/markets/mbs/.
A multi-price reverse auction is one in which participants enter prices at which they are willing to sell securities to
the New York Fed. The offers are ranked according to their attractiveness and selected until the desired quantity isachieved, much like in the case of a single-price auction. In the case of a multi-price auction, winners of the auction
pay the price they submitted, whereas for a single-price everyone pays the clearing price.
19
A tentative two-week schedule of Treasury operations was announced on a biweekly basis, while agency
operations were announced one day ahead. Providing advance notice of auctions helped to boost participation by
allowing dealers time to assess and adjust their inventories.
20
Summaries for Treasury purchases are available at http://www.newyorkfed.org/markets/pomo/display/index.cfm.
Summaries for agency purchases are available at
http://www.newyorkfed.org/markets/pomo/display/index.cfm?opertype=agny.
18

- 11 The approach for each program was similar, but not identical, as due consideration needed to begiven to the unique features of each asset class. In general, the composition of purchases wastilted towards longer-maturity or longer-duration securities in order to enhance the portfolio
balance effect and reduce longer-term interest rates. But purchases included a range ofmaturities in order to minimize any distortions in the yield curves for these assets. Within eachsector, the New York Fed focused purchases on assets that appeared to be underpriced relative toother assets within that sector, in some cases reflecting reduced market liquidity as discussed
above. These assessments were made using modeled yield curves and fair market values forsecurities to be purchased.21 The overall pace of purchases had to be high enough to achieve the
FOMC’s targets within the stated time frame, but allowed for some variation from day to day
based on market liquidity conditions.
As noted earlier, purchases of agency debt and MBS began at a time when liquidity inthese markets was poor and spreads to Treasury yields were unusually wide. In thesecircumstances, LSAPs helped to improve market liquidity by providing a large buyer for thesesecurities on a consistent basis. Spreads of MBS and agency yields narrowed relative toTreasury yields, and spreads between on-the-run and off-the-run Treasury securities narrowed.
Trading flows increased and market participants reported narrower bid-ask spreads in thesemarkets, reflecting improved liquidity. However, as financial conditions improved over thecourse of the programs, the programs became more of an impediment to market liquidity byremoving such a large amount of the available supply. Some market analysts argued that therelatively rich pricing of agency debt and MBS was also having a negative impact on market
liquidity because it was driving some major investors out of these markets. But, displacing
21

For Treasury and agency debt purchases, underlying discount curves were estimated from prices of a current
cross-section of comparable securities from the same issuer to generate a fair valuation for securities being
purchased. In the case of MBS, valuations between different securities were compared to historical norms.

- 12 agency debt and MBS investors to a significant extent was an unavoidable element of the
programs that was necessary for achieving their goals. Despite periodic strains, these markets
generally continued to function with adequate liquidity, in that investors could trade relatively
large amounts of securities with little effect on market prices.
Because the MBS purchases were arranged with primary dealer counterparties directly,
there was no auction mechanism to provide a measure of market supply. Instead, the New YorkFed aimed to adjust the pace of purchases of each class of MBS in response to measures ofwhether that class appeared relatively cheap or expensive, driven in part by changes in liquidity.
To avoid buying at excessively high prices and to support market functioning, purchases wereincreased when market liquidity appeared to be good and were reduced when liquidity appeared
to be poor. Different measures of liquidity were used to make these adjustments, including
measures of trading volumes, relative price valuations, bid-ask spreads, and indications of supply
imbalances. Throughout the program, the pace of daily purchases ranged from $2 to $9 billion.22
In terms of composition, the Federal Reserve purchased MBS in all coupon classes, butpurchases were concentrated in the “production,” or newly-issued, 30-year securities, whichwere generally more liquid than other securities in the MBS market. It was felt thatconcentrating purchases on production MBS would help to reinforce the decline in primarymortgage rates by providing mortgage originators with a deep and ready market for new loans.
In the case of agency debt, the New York Fed adjusted the amount of securities
purchased in each operation in response to the total amount of propositions submitted, provided
that these propositions were at competitive prices. This strategy was used in order to target

22

The program also made purchases and sales in the MBS dollar roll market to help support financing of dealer
MBS portfolios and to smooth out temporary fluctuations in the supply of particular coupon categories of MBS. In
a dollar roll purchase, the buyer purchases MBS for the current delivery month and simultaneously sells
substantially similar MBS for a future delivery month.

- 13 different segments of the maturity spectrum optimally from the perspective of market
functioning and liquidity. The program initially focused on off-the-run securities, but asliquidity improved and yield spreads for these securities narrowed, on-the-run securities wereadded to the eligible set of securities in September 2009 in order to mitigate market dislocations
that had developed during the program.
Concerns about market functioning and liquidity were generally lower in the Treasury
LSAP program, as that program was much smaller in relation to the size of the market and to thelevel of typical trading flows. As such, neither the pace nor the composition of purchases was
adjusted significantly throughout the program. The amount of propositions in each operation
routinely exceeded the targeted quantity by three times or more.
Purchases of agency debt were concentrated in medium-term securities because of thesmall outstanding supply at longer maturities (Chart 1). Purchases of agency MBS wereconcentrated in low-coupon 30-year securities issued by Fannie Mae and Freddie Mac (Chart 2).
Purchases of Treasury securities were concentrated in the 2- to 10-year maturity sectors (Chart
3). The pace of purchases evolved fairly smoothly over the course of the program. Totalpurchases ranged between $50 and $200 billion on a monthly basis (Chart 4). Purchases were
somewhat heavier from March 2009 through June 2009, reflecting the expansion of the LSAP
programs at that time and the large amount of MBS purchases made to offset heavy origination
activity. The decision to taper purchases led to a slowing pace of purchases after the middle of2009.23
Public communications were an important part of the LSAP programs. The Federal
Reserve released a press statement shortly after the initial announcement of each program
23

The decision to gradually slow the pace of Treasury purchases was announced in the August 2009 FOMC
Statement. The decision to gradually slow the pace of agency purchases was announced in the September 2009
FOMC Statement.

- 14 providing further details about the timing and overall structure of each program. Documents
providing answers to frequently asked questions were released at the start of each program.
These documents provided details as to what types of securities were eligible for purchase andwhat investment strategy would be employed, and they were updated to reflect changes in the
programs, such as the increase in the targeted size of the agency debt and MBS programs or the
inclusion of on-the-run securities for purchase in the agency debt program. The timely release of
information was provided in order to reduce uncertainty and speculation around operational
details.
4. Estimates of LSAP Effects
4.1 Previous Studies
According to the expectations theory of the term structure, altering the maturity of the net
supply of assets from the government to private investors should have only minimal effects on
the term structure of interest rates. This view was supported by the literature studying Operation
Twist in the early 1960s, which did not find robustly significant effects of a swap between shortterm and long-term Treasury securities in the Fed’s SOMA portfolio.24 However, as noted by
Solow and Tobin (1987), Federal Reserve purchases during Operation Twist were small andwere soon more than offset by increased Treasury issuance of long-term debt. Overall, there waslittle movement in the average maturity of Treasury debt held by the public and thus little hopeof estimating a statistically significant and robust effect.
Subsequent time-series studies, using longer spans of data, generally have found a24See, for example, Modigliani and Sutch (1967). The current program differs from Operation Twist in that the
reduction in long-term bonds is financed by reserve creation rather than sales of short-term Treasury bills. However,with interest rates on bank reserves and short-term bills roughly equal in the current environment, the two assets
should be viewed as close substitutes and thus the effect on the term spread should be similar.

- 15 noticeable effect of shifts in the maturity structure of Treasury debt on the term structure.25 The
estimated size of this effect depends on the degree of theoretical restrictions imposed on theestimating equation. Tighter restrictions implied by simple models of household behavior
generally lead to smaller estimates, but these restrictions typically are rejected statistically infavor of less restrictive specifications. Other time-series studies, while not focusing on thematurity structure of public debt, have found that increases in the total supply of public debt tend
to raise longer-term interest rates.26 Bernanke, Reinhart, and Sack (2004) adopt an alternative
approach to time-series analysis. They examine specific news events concerning future Treasury
issuance or purchases of longer-term securities and find that longer-term yields dropped
significantly on days in which the market learned of future declines in the net supply of longerterm Treasury securities. In this paper, we employ both time-series and event-study
methodologies to gauge the overall effects of the LSAP programs.
4.2 An Event Study of Recent LSAP Communications
In this section we use an event-study analysis of Federal Reserve communications toderive estimates of the effects of LSAPs. In particular, we examine changes in interest rates
around official communications regarding asset purchases, taking the cumulative changes as ameasure of the overall effects. In doing so, we implicitly assume that: (1) our event set includes
all announcements that have affected expectations about the total future volume of LSAPs, (2)LSAP expectations have not been affected by anything other than these announcements, (3) we
can measure responses in windows wide enough to capture long-run effects but not so wide that
information affecting yields through other channels is likely to have arrived, and (4) markets are25

All of the studies focused on the United States. See Friedman (1981), Frankel (1985), Agell and Persson (1992),
Kuttner (2006), and Greenwood and Vayanos (2010).
26
See Engen and Hubbard (2005), Gale and Orszag (2004), and Laubach (forthcoming). Warnock and Warnock(2009) also find that purchases of U.S. debt by foreign governments tend to lower U.S. long-term interest rates.

- 16 efficient in the sense that all the effects on yields occur when market participants update their
expectations and not when actual purchases take place.27
The financial variables we examine are the 2-year and 10-year Treasury yields, the 10year agency debt yield, the current-coupon 30-year agency MBS yield, the 10-year Treasury
term premium (based on Kim and Wright, 2005), the 10-year swap rate, and the Baa corporatebond index yield.28 Swap rates and corporate bond yields help us to gauge the extent to whichnews about LSAPs affected yields on assets that were not purchased by the Federal Reserve.
We focus on a narrow set of official communications, each of which contained new
information concerning the potential or actual expansion of the size, composition, and/or timingof LSAPs. The eight announcements included in this “baseline” event set are:

The initial LSAP announcement on November 25, 2008, in which the Federal Reserveannounced it would purchase up to $100 billion in agency debt, and up to $500 billion inagency MBS;

Chairman Bernanke’s December 1, 2008 speech, in which he stated that in order toinfluence financial conditions, the Fed “could purchase longer-term Treasury
securities…in substantial quantities”;

27

These are strong assumptions. The need for them arises in part because we do not have a direct measure of
expectations about the size of future LSAPs. With such a measure, we could use announcements to identify
exogenous shocks to LSAP expectations. The corresponding yield responses could then be used to derive statisticalestimates of the effects of changes in expectations and, from these, the total effects of LSAPs could be extrapolated.
Such an approach is typical of studies of the effects of surprise changes to the target federal funds rate, using interest
rate futures contracts to measure market expectations. A particular challenge in isolating the effects of LSAPs isthat the announcements we identify are likely to have contained non-LSAP information relevant to yields, including
policy measures and updates to the FOMC’s economic outlook. As a result, it is impossible to draw a response
window narrow enough to include only the effects of LSAPs.
28
We measure agency debt yields using Freddie Mac’s on-the-run fixed-rate senior benchmark non-callable note; asof February 1, 2010, Fannie Mae had not issued a 10-year note since 2007. On-the-run agency debt was notincluded in LSAPs until September 2009, but the cumulative changes in the first off-the-run yield are almost
identical to the changes in the on-the-run yield. The MBS yield is the average of the Freddie Mac and Fannie Maecurrent-coupon 30-year agency MBS yields. The interest rates are from Bloomberg, except for the Baa yield, whichis from Barclay’s Capital. The Kim-Wright term premium data are made available by the Federal Reserve Board atwww.federalreserve.gov/econresdata/researchdata.htm. The Kim-Wright term premium is based on implied zerocoupon yields on off-the-run securities, whereas the Treasury yield series are for on-the-run coupon securities.

- 17 The December 2008 and January 2009 FOMC statements, which indicated that the
FOMC was considering expanding purchases of agency securities and initiatingpurchases of longer-term Treasury securities;



The March 2009 FOMC statement, in which the FOMC announced the decision topurchase “up to” $300 billion of longer-term Treasury securities, and to increase the sizeof agency debt and agency MBS purchases to “up to” $200 billion and $1.25 trillion,
respectively;

The August 2009 FOMC statement, which dropped the “up to” language qualifying the
maximum amount of Treasury purchases, and announced a gradual slowing in the pace of
these purchases;

The September 2009 FOMC statement, which dropped the “up to” language qualifying
the maximum amount of agency MBS purchases, and announced a gradual slowing in thepace of agency debt and MBS purchases; and

The November 2009 FOMC statement, which stated that the FOMC would purchase“around $175 billion of agency debt.”
We consider the response of interest rates using one-day windows around theannouncements, measured from the closing level the day prior to the announcement to theclosing level the day of the announcement.29 Selecting the window length involves a trade-off
between allowing sufficient time for revised expectations to become fully incorporated in asset
prices and keeping the window narrow enough to make it unlikely to contain the release of otherimportant information. Although event studies often examine intraday price changes in order toavoid the pollution of measured responses by extraneous information, we believe a wider29

We use the two-day change for the MBS yield around the March 2009 FOMC meeting because of an error in the
Bloomberg MBS yield series on March 18. As discussed below, we also tried using two-day windows for all eventdays and interest rates.

- 18 window is suitable in this context. Specifically, given the novelty of the LSAPs and the diversityof beliefs about the mechanisms by which they operate, changes may have been absorbed more
slowly than for typical monetary policy shocks (such as those to the federal funds target rate).
Table 1 displays the changes in interest rates on each day in the baseline event set
described above as well as on days in which the FOMC issued communications concerning theLSAPs that provided little new information. Chart 5 displays the cumulative changes in interest
rates across the eight announcements in the baseline event set. All interest rates declined
notably, with the 10-year Treasury yield, 10-year agency debt yield, and current-coupon agency
MBS yield declining 91, 156, and 113 basis points, respectively. The large change in the 10-year
Treasury yield relative to the 2-year Treasury yield suggests that the announcements reduced
longer-term rates principally by reducing the term premium, as opposed to signaling acommitment to keep policy rates low for an extended period of time. This inference isconfirmed by the large cumulative drop in the Kim-Wright 10-year term premium measure. The
relatively large changes in agency debt and agency MBS yields demonstrate that the LSAPs also
helped to lower spreads of the yields on these assets relative to those on Treasury securities. The
substantial declines in the swap rate and the Baa corporate bond yield show that LSAPs had
widespread effects, beyond those on the securities targeted for purchase.
Some observers, noting that the 10-year Treasury yield has not declined on net since theinception of the LSAP programs, have argued that the LSAPs did not have a lasting effect. Chart
6 compares the net changes in interest rates on the baseline event days to the net changes on allother days since November 2008. The 10-year Treasury yield and swap rate increased nearly
100 basis points on non-event days, and are hence roughly unchanged over the entire period.
However, there were many factors at play that would have been expected to lift Treasury yields

- 19 over that period, including a very large increase in the expected future fiscal deficit, a significant
rebound in the economic outlook, and a sharp reversal of the flight-to-quality flows that had
occurred in the fall of 2008.30 It is likely those factors, and not a reversal of the effects of the
LSAP announcements, that drove Treasury yields higher on other days. Supporting that view,other interest rates showed very different patterns than that of the 10-year Treasury yield on nonevent days. The agency debt yield and the MBS yield were little changed, and the Baa corporatebond yield dropped about 400 basis points. This combination of a rising Treasury yield and afalling corporate bond yield is consistent with the relaxation of the extreme financial strains andflight-to-quality that characterized the early part of 2009, and it highlights the importance ofzeroing in on event days to measure the effects of LSAPs separately from the effects of otherdevelopments.
Finally, Chart 7 plots cumulative interest rate changes using two modifications to ourevent study. In the first, we continue to use one-day response windows, but expand the event set
to include all FOMC statements and minutes between November 2008 and January 2010 to allow
for the possibility that markets gleaned information about the future of LSAPs from thesecommunications. In the second, we use the same baseline event set as above, but extend the
response window to two days to allow for lagged reactions to the news by some market
participants. Most of the measured effects of the LSAPs change only modestly using thesealternative parameterizations of the event study. Using the expanded event set, the cumulative
declines are between 10 basis points larger and 30 basis points smaller than with the baseline set.
The smaller declines may reflect that markets had attributed some probability to further increases

30

On December 10, 2008, the Blue Chip Economic Indicators survey average projection of the fiscal year 2009
federal deficit was $672 billion. In January 2010, the Congressional Budget Office estimated the 2009 deficit at$1587 billion and projected the 2010 deficit at $1381 billion. The Conference Board’s Index of Leading Economic
Indicators rose from 99.2 in November 2008 to a preliminary estimate of 107.4 in January 2010.

- 20 in the LSAPs and that these expectations were adjusted downward when the FOMC did not
move in that direction on the non-baseline event days. On the other hand, using two-day
response windows, the cumulative declines are 0 to 40 basis points larger than with the one-day
windows, suggesting that it may have taken more than one day for the market to fully adjust tothese communications.31
To more carefully evaluate whether the effects found above arose through the term
premium, as would be expected from the theoretical discussion in section 2, we focus on yield
movements around the two FOMC announcements that also contained new language on theprospects for future short-term interest rates. In particular, on December 16, 2008, the FOMC
stated its view that the federal funds rate was likely to remain at “exceptionally low levels forsome time.” On March 18, 2009, the FOMC modified this language to “exceptionally low levels
for an extended period.” We want to make sure that the yield movements around those dates do
not reflect a decline in expected future short-term interest rates associated with those statements.
One way to approach this issue is to rely on the Kim-Wright model used above to
examine the market interest rates with maturities that are most likely to be affected by the FOMC
statements concerning the future federal funds rate. Any movement in the expected federal
funds rate at these horizons is likely to be much greater than the average movement in the
expected federal funds rate over the next 10 years. We focus on the movement in the estimated
one-year-ahead instantaneous interest rate around the release of the FOMC statements.32
According to the Kim-Wright model, the one-year-ahead expected instantaneous interest rate
dropped only 4 basis points on December 16, 2008 and then rose 16 basis points the following
31

MBS yields, in particular, may have taken longer to respond fully to these communications. Adding a third day to
the windows increases the cumulative decline of MBS yields by more than 30 basis points, whereas it has little
effect on the cumulative declines in the other yields.
32
The instantaneous interest rate is a construct of the Kim-Wright model that is essentially equivalent to the federal
funds rate.

- 21 day.33 An alternative gauge of market expectations is the one-year-ahead forward instantaneousinterest rate, as the term premium would presumably be limited in size at this horizon.34 Thisrate dropped 11 basis points on December 16, but then rose 17 basis points the following day.
On March 18, 2009, the Kim-Wright one-year-ahead expected instantaneous interest rate
dropped 4 basis points and rose by the same amount on the following day.35 The one-year-ahead
forward instantaneous rate dropped 28 basis points on March 18, but about half of this decline
was unwound over the next few days. Overall, these observations on expected future andforward interest rates suggest that the December 2008 and March 2009 FOMC statements did nothave substantial effects on market expectations of the future path of the federal funds rate—certainly not enough to explain the substantial decline in longer-term interest rates on thosedays.36
In principle, the LSAP programs could have raised the expected future path of the federal
funds rate by accelerating the expected pace of economic recovery. In this case, the LSAP effecton the term premium would be greater than the effect on the long-term Treasury yield.
According to Table 1, however, the LSAP effects on the 10-year Treasury yield are slightly
larger than those on the 10-year term premium, suggesting that LSAPs did not raise the expected
future federal funds rate.
Altogether then, we find that longer-term interest rates declined by up to 150 basis points
around key LSAP announcements. Moreover, the majority of the decline in the 10-year Treasury
33

The two-year-ahead expected instantaneous interest rate dropped 6 basis points on December 16 and rose 4 basis
points on December 17.
34
The forward rate is the sum of the expected future instantaneous rate and the forward term premium. It can bederived directly from the yield curve without requiring any modeling of, or assumptions about, its components
beyond those required to fit a yield curve to observed bond yields.
35
The two-year-ahead expected instantaneous interest rate dropped 14 basis points on March 18 and rose 3 basis
points on March 19.
36
It is possible that these FOMC statements affected the term premium directly by reducing uncertainty about thepath of future interest rates. Estimating this effect is beyond the scope of this paper, but we believe such effects arelikely to have been small.

- 22 yield around these announcements can be attributed to declines in the term premium. Chart 7
shows that, depending on the event set and response window used, LSAP announcements
reduced the 10-year term premium by between 50 and 100 basis points. Little of the observed
declines in longer-term yields appears to reflect declining expectations of future short-term
interest rates associated with FOMC communications about the likely future path of the federal
funds rate.
4.3 Time Series Analysis of Longer-term Treasury Supply
In this section, we use a different method and different data to measure the impact ofasset purchases (or sales) on the 10-year term premium.37 Specifically, we estimate statisticalmodels that explain the historical variation (prior to the announcement of the LSAP programs) inthe term premium using factors related to: (1) the business cycle, (2) uncertainty about economic
fundamentals, and (3) the net public-sector supply of longer-term dollar-denominated debt
securities. Using a variety of model specifications, we estimate the effects of changes in thestock of longer-term debt held by private investors on the term premium. We then use theseresults to estimate the (out-of-sample) impact of the Federal Reserve’s asset purchases, which
represent a reduction in the supply of longer-term debt securities to private investors.
Following Backus and Wright (2007), we explain historical time-variation in the term
premium using an ordinary least squares regression model of the form:

whereis the nominal 10-year yield term premium, andis a set of observable factors.38

However, we expand on the set of explanatory variables used by Backus and Wright, focusing on
37

The term premium likely captures the largest component of the LSAPs’ effects on private borrowing rates.
However, as we highlighted in Section 2, LSAPs also affected other components of risk premiums. The statisticalmodels here do not attempt to estimate these other effects, or the effects on term premiums at different horizons.
38
Whereas Backus and Wright modeled the instantaneous forward term premium 10-years ahead, we focus on the
10-year yield term premium, given our interest in exploring the purchases’ effects on longer-term interest rates.

- 23 the three types of variables noted above.39
In particular, the following variables are included to capture term premium variation
related to the business cycle and fundamental uncertainty:

Unemployment gap: measured as the difference between the unemployment rate and theCongressional Budget Office’s estimate of the natural rate of unemployment.

Core CPI inflation: a second measure of the macroeconomic state, the 12-month change
in core CPI, may also proxy for inflation uncertainty.40

Long-run inflation disagreement: measured as the interquartile range of 5- to 10-year
ahead inflation expectations, as reported by the Michigan Survey of Consumers.41



6-month realized daily volatility of the on-the-run 10-year Treasury yield: a proxy forinterest rate uncertainty. We use this instead of option-implied volatility because it isavailable over a longer period.42
To capture the effects of changes in the net public-sector supply of longer-term debt

securities, we use the following time series, each of which is expressed as a percent of nominalGDP:

Publicly-held Treasury securities with at least one year to maturity, including securities
held by private investors as well as those held by the Federal Reserve and by foreign
official institutions.

39

In early analysis we also included a measure of the on-the-run Treasury liquidity premium as a proxy for the“flight-to-quality” demand for Treasuries. However, the coefficient on this term was never significant, andexcluding it did not affect the magnitude or significance of the other coefficients. For ease of exposition, we omit it
here.
40
Mankiw, Reis, and Wolfers (2004) show that inflation disagreement, the level of inflation, the absolute value ofthe change in inflation, and relative price variability positively co-vary.
41
We use the Michigan survey because of its long history and relatively high frequency (monthly), but our results
are not significantly affected if we use long-run inflation disagreement taken from the Blue Chip Economic
Indicators survey instead. The Michigan survey did not include the long-run inflation question during some months
during the 1980s. We linearly interpolate the series where data are missing.
42
Realized and implied volatility are highly correlated at the monthly frequency, and our modeling choice does notappear to substantively alter the results.

- 24 Treasury securities held in the Federal Reserve’s SOMA portfolio with at least one year
to maturity.43



U.S. debt securities held by foreign official agencies, with at least one year to maturity.
This measure includes Treasury securities, agency-related securities, and corporate
bonds, and is interpolated from annual stock surveys, using monthly Treasury
International Capital (TIC) flows, by the Board of Governors of the Federal Reserve
System.44
An important assumption of our statistical analysis is that these longer-term debt stock

variables are exogenous with respect to the term premium. For example, this assumption implies
that the Treasury does not issue more longer-term debt when the term premium declines. To theextent that these public-sector agencies do respond to term premiums in a manner similar to
private investors, that is, by buying more longer-term debt (or selling less longer-term debt)
when the term premium is high, our estimates of the effect of public-sector longer-term debt
supply on the term premium will be biased downward. Overall, we believe it is reasonable toassume that these public agencies respond very little to term premiums. However, our estimates
may be viewed as somewhat conservative owing to this potential downward bias.
The response of private investors to the net public-sector supply of assets should not beaffected by the specific public-sector agency doing the purchases or sales. Thus, when the
Treasury buys back a longer-term security, it should have the same effect on longer-term yields
as when the Federal Reserve buys that security or when a foreign official agency buys that
security (assuming that each is expected to hold the security on a persistent basis and controlling43

As noted above, the SOMA held agency securities between 1971 and 2003. However, these were a very small
portion of total SOMA holdings (less than 5 percent), and information on the maturity and duration of these holdings
is not available.
44
See Bertaut and Tryon (2007). The data are available at
http://www.federalreserve.gov/pubs/ifdp/2007/910/default.htm.

- 25 for any policy signals the purchases convey). Moreover, the term premium should be roughly
equally affected by public-sector purchases of either Treasury securities or agency-related
securities with similar durations. Accordingly, the appropriate measure of the net supply of
longer-term debt securities by the public sector would include longer-term Treasury securities
less the total amount of longer-term debt held by the SOMA and by foreign official institutions.45
We estimate models with this measure of the net supply of longer-term debt expressed in both
unadjusted terms and as 10-year Treasury equivalents.46 The duration adjustment captures
relevant variation in the composition of the outstanding stock of debt securities.47
We estimate the model on monthly data over the period January 1985 to June 2008. This
period was selected because it is the full sample over which data on each of the variables isavailable, and because it ends shortly before the initial announcement of asset purchases in thefall of 2008. The first two columns of Table 2 present results from a regression of the 10-year
term premium on the explanatory variables, using the unadjusted net debt stock measure. The
third and fourth columns present results using the duration-adjusted net debt stock. For
comparison, in this and subsequent tables, we include estimates from the model without any debt
supply variable in the final columns.
The results are similar with either measure of the debt stock. The explanatory variables

45

We do not include privately issued debt securities held by private investors because these securities have a net
zero supply from the point of view of the private sector, and because demand and supply for them are likely notexogenous with respect to the term premium.
46
The unadjusted stock of Treasury securities with remaining maturity greater than one year is obtained from Table
FD-5 of the Treasury Bulletin. This table excludes SOMA holdings but includes foreign official holdings, which we
subtracted using the TIC data described above. The duration-adjusted stock of non-SOMA Treasuries comes from
Barclay’s Capital, and, unlike the unadjusted measure, excludes Treasury Inflation-Protected Securities (TIPS). In
the duration-adjusted regressions we use foreign holdings of long-term Treasury securities only (i.e., not agencyrelated securities or corporate bonds), and assume that these have the same duration as non-SOMA Treasuries heldby the public. Because we cannot isolate foreign holdings of TIPS, the adjusted stock variable may understateholdings (by subtracting TIPS holdings from a total stock measure that already excludes it). The effect should beminor.
47
As described in Section 2, the adjustment converts the amount, S, into an amount of 10-year Treasury securities
with the same portfolio duration: 10-year equivalents = S*duration(S)/duration(10y).

- 26 are almost all significant at the one percent level and always have the expected sign.
Specifically, one percentage point increases in the unemployment gap, core CPI inflation,
inflation disagreement, and realized volatility increase the term premium about 20, 30, 40, and100 basis points, respectively. As for the supply variables, a one-percent-of-GDP increase inlonger-term debt supply increases the 10-year term premium by 4.4 basis points on an unadjusted
basis, and 6.4 basis points when expressed in terms of 10-year Treasury equivalents.48 Bothcoefficients are statistically significant at the one percent level.49
The $1.725 trillion in committed purchases by the Federal Reserve is roughly 12 percent
of 2009Q4 nominal GDP (based on the Advance Estimate), which, according to the estimates in
the first column, implies that total Federal Reserve asset purchases have reduced the term
premium by 52 basis points (assuming that markets have fully priced in the effect already). If
the ratio of the duration of agency debt and MBS to the duration of the 10-year Treasury security
is assumed to be the same for remaining purchases as it has been for the roughly $1.3 trillion inagency debt and MBS purchased through February 1, 2010, the Federal Reserve will havepurchased a total of approximately $850 billion in 10-year equivalents.50 This is roughly 6
percent of 2009Q4 nominal GDP, which implies that asset purchases reduced the term premiumby 38 basis points.
None of the variables included in the model can grow or decline without bound, and thus
48

We cannot reject that the debt stock coefficients are constant between the first and second halves of the sample.
If the debt stock components—Treasury, SOMA, and TIC—are entered separately into the regression, thecoefficients on SOMA and TIC are a bit larger and the coefficient on Treasury is considerably smaller than thecoefficient on the combined variable. We suspect that the smaller separate Treasury estimate arises because shifts inthe supply of long-term Treasury securities are anticipated far in advance. In the regressions reported here wenevertheless impose the assumption that the effects are the same.
50
As of February 1, 2010, the $300 billion in completed Treasury purchases equaled $169 billion 10-year
equivalents, agency debt purchases of $164 billion equaled $59 billion 10-year equivalents, and agency MBS
purchases of $1160 billion equaled $573 billion 10-year equivalents. Thus, the $1625 billion in completed
purchases equaled $802 billion 10-year equivalents. When scaled up along the lines suggested in the text, we arrive
at total expected purchases of $850 billion 10-year equivalents, which is 5.9 percent of 2009Q4 nominal GDP (basedon the Advance Estimate of $14.5 trillion). The duration-adjusted amount of assets purchased will change over timeas the slope of the Treasury yield curve and duration of agency debt and MBS holdings change.
49

- 27 there is a strong presumption that they are stationary. However, some of them may have asufficiently large autocorrelation to appear nonstationary within our 23-year estimation sample.
Thus, we also use dynamic ordinary least squares (DOLS) based on Stock and Watson (1993) toestimate the long-run relationship (also known as the cointegrating vector) between the term
premium and the explanatory variables. In addition to the levels of our explanatory variables,
the contemporaneous, lead, and lagged first differences of each are included as regressors.51 The
level term coefficients from the DOLS regression estimate the long-run relationship between thevariables, and the deviation of the term premium from this long-run relationship is referred to as
the cointegration error. Regressing the change in the term premium on the contemporaneouschange in the explanatory variables and on the lagged level of the cointegration error allows us toestimate the long-run adjustment speed of the cointegrating relationship and to test thesignificance of the cointegrating relationship.
The first two columns of Table 3 present results from the DOLS model, again estimatedover the period January 1985 to June 2008. The long-run effects of changes in the longer-term
debt stock are almost identical to those obtained in Table 2. Specifically, an increase in longerterm debt equal to one percent of GDP increases the term premium by just over 4 basis points inthe unadjusted specification and by just over 6 basis points in the duration-adjusted specification.
The adjustment speed parameters of -0.15 imply that deviations in the term premium from longrun equilibrium have a half-life of roughly five months. The t-statistics on the adjustment speeds
51

The following procedure was used to select the leads and lags included within the DOLS regression. We startwith a single lead and lag of the first difference of each explanatory variable. If the lead or lag for a variable wasstatistically significant at the 5 percent level (using Newey-West standard errors with 12 lags), we added one more,
and removed all leads and lags that were not significant. If the added lead or lag was still significant, we added four
more. For each specification this was enough to make the leads and lags of the longest length statisticallyinsignificant. For robustness, we also estimated the model using 6 leads and lags of the first differences. The
coefficient estimates on supply in the cointegrating vectors were virtually unchanged from those derived according
to the selection procedure just described.

- 28 are -5.7 and -6.3, which are sufficiently large to reject the hypothesis that these variables do nothave a stable long-run relationship (that is, they are not cointegrated) at the 1 percent
significance level. Note that the adjustment speed drops substantially when the debt stock
variables are excluded (the final columns), suggesting that the longer-term debt stock is an
important part of the long-run relationship.
The preceding regressions are based on the Kim-Wright model of the 10-year term
premium, which was estimated over a sample that does not include a major financial crisis ormonetary policy constrained by the zero bound on nominal interest rates. As a robustness check,
we also estimate a specification that uses the 10-year Treasury yield as the dependent variable
and that includes the target federal funds rate and the slope of the near-term eurodollar futures
curve to proxy for the expected path of policy rates.52 Under the assumption that the two
additional variables adequately control for expected future policy interest rates, the estimatedcoefficients on the other variables should continue to reveal their impact on the 10-year term
premium. Note that another reason for focusing directly on the behavior of the 10-year yield isthat the ultimate goal of LSAPs is to lower longer-term private borrowing rates, many of which
are highly correlated with 10-year Treasury yields. As the first and third columns of Table 4
show, the estimated longer-term debt supply effects are somewhat higher in this specification
than in the term premium regressions. The estimated coefficients of 0.07 and 0.10 on theunadjusted and duration-adjusted debt stocks imply that LSAPs have reduced the 10-year term
premium by 82 basis points (unadjusted model) or 58 basis points (duration-adjusted model).53
52

Specifically, we use the difference between the implied rates on Eurodollar futures contract settling approximately
two-years and one-year ahead.
53
Using a longer sample and somewhat different specification, Greenwood and Vayanos (2010) also find astatistically significant effect of bond supply on the bond yields. They regress the spread of the 5-year Treasury
yield to the 1-year Treasury yield and the spread of the 20-year yield to the 1-year yield on the ratio of Treasury
securities with maturities greater than 10 years to total Treasury securities. They do not subtract SOMA or TIC
holdings. Over the period 1952-2005, they find that a one percentage point increase in the share of Treasury

- 29 Table 5 summarizes the estimated coefficients on longer-term debt stock across our
specifications and lists the implied effects of the Federal Reserve’s asset purchases on the 10year term premium. Our results suggest that the $1.725 trillion in announced purchases reduced
the 10-year term premium by between 38 and 82 basis points. This range of point forecasts
overlaps considerably with that obtained in our event study, which is impressive given thatentirely separate data and methodologies were used to obtain the results.54
5. Conclusion
With policy interest rates in many countries constrained by the zero bound, and withshort-term interest rates in Japan having been near zero for over a decade, expanding the toolkit
of monetary policy is an important objective. In this paper, we examined lessons from theexperience of the Federal Reserve since late 2008 with one of the key policy tools available atthe zero bound—large-scale purchases of longer-term assets.
By reducing the net supply of assets with long duration, the Federal Reserve’s LSAP
programs appear to have been successful in reducing the term premium. The overall size of the
reduction in the 10-year term premium appears to be somewhere between 30 and 100 basis
points, with most estimates in the lower and middle thirds of this range. In addition to thisreduction in the term premium, the LSAP programs had an even more powerful effect on longerterm interest rates on agency debt and agency MBS by improving market liquidity and by
removing assets with high prepayment risk from private portfolios.
Based on this evidence, we conclude that the Federal Reserve’s LSAP programs weresecurities with maturities above 10 years increases the 5-year yield spread 4 basis points and the 20-year yieldspread 8 basis points.
54
The event study range is somewhat higher than the time series range. This difference may reflect that LSAP
effects are larger when financial conditions are strained. Alternatively, it is possible that the effect of maturity
supply on bond yields is nonlinear, so that large reductions in net supply have a proportionally larger (or smaller)
effect on yields. The LSAP programs constituted a large shift in maturity supply by historical standards.

- 30 successful at lowering longer-term private borrowing rates and stimulating economic activity.
While the effects are especially noticeable in the mortgage market, they appear to be widespread,including in the markets for Treasury securities, corporate bonds, and interest-rate swaps. That
conclusion is promising, as it means that monetary policy remains potent even after the zerobound is reached. To be sure, achieving this further stimulus was not without its challenges, as it
required a sizable expansion of the Federal Reserve’s balance sheet, and the purchase of such alarge volume of securities in a relatively short time frame required surmounting some operational
hurdles. However, by restoring functioning to the mortgage market and lowering the term
premium, the programs provided considerable benefits.
Even though the LSAPs appear to have been successful, it is worth reflecting on theirstructure and considering whether the approach taken was optimal. The LSAPs, as implemented,
were discrete in nature, in that the broad characteristics of the programs were set in two decisions
upfront (in November 2008 and March 2009). The remainder of the programs involved carryingout those decisions, with little responsiveness to changes in the economic or financial outlook.
By stating a specific amount and a timetable for LSAPs upfront, the FOMC appeared tocommit itself to a future course of action. This commitment was softened somewhat by the useof the phrase “up to” before the specified purchase amounts. However, market participants
generally indicated that they expected the full amounts to be purchased, and in the later stages ofthe programs the FOMC made it clear that close to the full amounts would be purchased.
Policymakers often prefer not to make strong commitments on future policies because there isalways a chance that future economic conditions will call for a different policy stance than
expected. If LSAPs again come to the forefront of the policy discussion, policymakers may wantto assess the benefits of this element of commitment relative to an approach that instead allows

- 31 greater responsiveness to economic and financial conditions. Bullard (2009) lays out thetheoretical case for a policy rule for LSAPs analogous to conventional policy rules for interest
rates, but he shows that the practical issues in designing such a rule are substantial, particularly
in light of the limited historical experience of economies operating near the zero bound on
nominal interest rates.55 Clearly, study of both the theoretical and empirical issues raised by
LSAPs would be helpful in order to assess whether they can be employed even more effectively
in the future.

55

An alternative strategy, proposed by Bernanke (2002), is to use unlimited purchases to target near-zero yields on
Treasury securities with successively longer maturities, starting with one-year securities. This strategy entails acompletely elastic response of LSAPs to interest rates on the targeted securities, but leaves open the question of how
to relate the choice of targeted maturities to economic conditions.

- 32 Table 1: Interest Rate Changes around Baseline and Extended Event Set Announcements

Date

Event

2y
UST

10y
UST

10y
Agy

Agy
MBS#

10y
TP

10y
Swap

Baa
Index

11/25/2008*

Initial LSAP Announcement

-2

-22

-58

-44

-17

-29

-18

12/1/2008*

Chairman Speech

-8

-19

-39

-15

-17

-17

-12

12/16/2008*

FOMC Statement

-9

-26

-29

-37

-12

-32

-11

1/28/2009*

FOMC Statement

10

14

14

11

9

14

2

3/18/2009*

FOMC Statement

-22

-47

-52

-31

-40

-39

-29

4/29/2009

FOMC Statement

1

10

-1

6

6

8

-3

6/24/2009

FOMC Statement

10

6

3

2

4

4

5

8/12/2009*

FOMC Statement

-2

5

4

2

3

1

2

9/23/2009*

FOMC Statement

1

-3

-3

-1

-1

-5

-4

11/4/2009*

FOMC Statement

-2

6

8

1

5

5

3

12/16/2009

FOMC Statement

-2

1

0

-1

1

1

-1

1/28/2010

FOMC Statement

-6

-1

0

-1

1

-1

0

1/6/2009

Minutes Release

0

-4

3

-17

-1

-9

-14

2/18/2009

Minutes Release

9

11

4

6

8

9

16

4/8/2009

Minutes Release

2

-4

-7

-9

-4

-6

-6

5/20/2009

Minutes Release

-5

-5

-5

-7

-4

-4

-10

7/15/2009

Minutes Release

7

13

16

16

10

16

7

9/2/2009

Minutes Release

-1

-6

-6

-4

-7

-8

-5

10/14/2009

Minutes Release

1

7

10

3

7

7

8

11/24/2009

Minutes Release

0

-5

-5

-9

-5

-6

-3

1/6/2010

Minutes Release

-2

6

5

4

6

7

-1

Baseline Event Set

-34

-91

-156

-113

-71

-101

-67

Baseline Set + All FOMC

-19

-62

-140

-123

-50

-83

-74

Cumulative Change: 11/24/08 to 1/28/2010

-39

30

-96

-109

21

20

-482

* Included in the baseline event set.
# Two-day change for agency MBS on March 18, 2009 due to a Bloomberg data error.

- 33 Table 2: OLS Regression of 10‐Year Term Premium, January 1985 – June 2008
Coefficient

Std Error

Coefficient

Std Error

Coefficient

Std Error-2.182***0.348-2.324***0.349-1.852***

0.334

Unemployment Gap

0.180**

0.064

0.185**

0.063

0.252***

0.070

Core CPI

0.307***

0.056

0.298***

0.057

0.480***

0.062

Inflation Disagreement

0.377**

0.131

0.394**

0.133

0.286*

0.123

Realized Volatility

0.943***

0.207

0.994***

0.206

0.944***

0.271

0.044***

0.009

-

-

-

-

Duration-Adjusted--

0.064***

0.014

-

-

Adjusted R-squared

0.84

0.84

0.78

Std Err of Regression

0.36

0.37

0.43

Number of Obs

282

282

282

Constant
Cyclical Factors

Uncertainty

SupplyUnadjusted

Newey West standard errors (12 lags). ***, **, * denote significance at the 1, 5, 10 percent levels.

- 34 Table 3: Dynamic OLS Regression of 10‐Year Term Premium, January 1985 – June 2008
Coefficient

Std Error

Coefficient

Std Error

Coefficient

Std Error-2.288***0.388-2.351***0.425-1.879***0.355

Unemployment Gap

0.222***

0.062

0.219***

0.063

0.283***

0.071

Core CPI

0.302***

0.065

0.281***

0.063

0.502***

0.067

Inflation Disagreement

0.458**

0.173

0.454*

0.180

0.292

0.152

Realized Volatility

0.822***

0.221

0.901***

0.229

0.867**

0.296

0.042***

0.008

-

-

-

-

-

-

0.062***

0.014

-

-

Adjustment Parameter^-0.154***0.03-0.151***

0.024-0.116***

0.021

ADF Test on Coint. Error#-6.051***-5.957***-3.441**

282

280

282

Constant
Cyclical Factors

Uncertainty

SupplyUnadjusted
Duration-Adjusted
Long-Run Properties

Number of Obs

Newey West standard errors (12 lags). ***, **, * denote significance at the 1, 5, 10 percent levels.
^ Estimated by regressing the change in the term premium on the contemporaneous change in each explanatory variable
and on the lagged level of the cointegration error.
#Null hypothesis: no cointegrating relationship- 35 Table 4: OLS Regression of 10‐Year Treasury Yield, December 1986 – June 2008
Coefficient

Std Error

Coefficient

Std Error

Coefficient

Std Error

0.297

0.432

0.103

0.443

-0.013

0.513

Target Fed Funds

0.403***

0.114

0.424***

0.118

0.742***

0.114

Eurodollar Slope

0.477*

0.214

0.478*

0.225

0.602*

0.273

Unemployment Gap

0.127

0.208

0.172

0.210

0.784***

0.198

Core CPI

0.378**

0.125

0.342**

0.131

0.163

0.157

0.210

0.165

0.215

0.170

0.111

0.187

1.057***

0.25

1.145***

0.27

1.340***

0.31

0.069***

0.014

-

-

-

-

Duration-Adjusted--

0.098***

0.023

-

-

Adjusted R-squared

0.92

0.91

0.88

Std Err of Regression

0.45

0.46

0.53

Number of Obs

259

259

259

Constant
Rate Expectations

Cyclical Factors

Uncertainty
Inflation Disagreement
Realized Volatility
SupplyUnadjusted

Newey West standard errors (12 lags). ***, **, * denote significance at the 1, 5, 10 percent levels.

- 36 Table 5a: Effect of One-Percent-of-GDP Increase in Long-Term Debt on 10-Year Term Premium
(bps)
OLS
Term Premium Model

DOLS
Term Premium
Model*

Yield Level Model

Unadjusted

4.4

4.2

6.9

Duration-Adjusted

6.4

6.2

9.8

* Long-run effect.

Table 5b: Total Effect of LSAPs on 10-Year Term Premium (bps)
OLS Term Premium
Model

DOLS
Term Premium
Model*

Yield Level Model

Unadjusted

52

50

82

[95% CI][31 to 74][31 to 69][50 to 115]

38

36

58

[22 to 54][20 to 53][31 to 84]

Duration-Adjusted[95% CI]* Long-run effect.

Note: As of February 1, 2010, Treasury purchases equaled $169 billion in 10-year equivalents, agency debt
purchases equaled $59 billion in 10-year equivalents, and agency MBS purchases (including unsettled
transactions) equaled $573 billion in 10-year equivalents. We assume that the ratio of 10-year equivalents tounadjusted amounts will be the same for future purchases as it has been for purchases through this date.

- 37 Chart 1: Distribution of Agency Debt Purchases by Maturity (through January 31, 2010)
100$ billion

80

60

40

20

0
0 - 3 mths

> 3 mths - 2years> 2 to 5 years> 5 to 10 years> 10 years

Maturity Bucket

Source: Federal Reserve Bank of New York

Chart 2: Distribution of MBS Purchases by Coupon (through January 31, 2010)
600
500$ billion

400
300
200
100
0
3.5

4

4.5

5
Coupon Rate

Source: Federal Reserve Bank of New York

5.5

6

6.5

- 38 Chart 3: Distribution of Treasury Purchases by Maturity100$ billion

80

60

40

20

0
1-2 Yrs

2-3 Yrs

3-4.5 Yrs

4.5-7 Yrs

7-10 Yrs

10-17 Yrs 17-30 Yrs

TIPS

Maturity Bucket
Source: Federal Reserve Bank of New York

Chart 4: Pace of Purchases by Asset Class (through January 31, 2010)
200$ billion

160
120
80
40

Treasury
Source: Federal Reserve Bank of New York

Agency Debt

Agency MBS

Total

Jan-10

Dec-09

Nov-09Oct-09Sep-09Aug-09Jul-09Jun-09

May-09Apr-09Mar-09Feb-09

Jan-09Dec-080

- 39 Chart 5: Cumulative Interest Changes on Baseline Event Set Days
0-34

basis points

-50

-67

-71
-91
-101

-100

-113

-156

-150

-200
2y
UST

10y
UST

10y
Agy

Agy
MBS

10y
TP

10y
Swap

Baa
Index

Source: Bloomberg, Barclay’s Capital

Chart 6: Cumulative Changes since November 2008, Event vs. non‐Event Days
200
100

basis points

0
-100
-200
-300
-400
-500
-600
2y
UST

10y
UST

Event Days
Source: Bloomberg, Barclay’s Capital

10y
Agy
Non-Event Days

Agy
MBS

10y
TP

10y
Swap

All Days: 11/24/08 to 1/28/10

Baa
Index

- 40 Chart 7: Cumulative Interest Rate Changes around Announcement Events, Alternative
Event Study Parameters0basis points

-50

-100

-150

-200
2y
UST

10y
UST
Baseline

Source: Bloomberg, Barclay’s Capital

10y
Agy

Agy
MBS

Baseline + All FOMC

10y
TP

10y
Swap

Two-Day Response

Baa
Index

- 41 References
Agell, Jonas, and Mats Persson. 1992. “Does Debt Management Matter?” In Agell, Persson, andFriedman (eds.), Does Debt Management Matter? Oxford: Clarendon Press.
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Bernanke, Ben. 2002. “Deflation: Making Sure ‘It’ Doesn’t Happen Here.” Remarks before the
National Economists Club, November 21.
Bernanke, Ben, Vincent Reinhart, and Brian Sack. 2004. “Monetary Policy Alternatives at the
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Swiss National Bank Research Conference, September 25.
Campbell, John, and Luis Viceira. 2001. “Who Should Buy Long-Term Bonds?” American
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Campbell, John, and Luis Viceira. 2005. “The Term Structure of the Risk-Return Tradeoff.”
National Bureau of Economic Research Working Paper No. 11119.
Engen, Eric, and R. Glenn Hubbard. 2005. “Federal Government Debt and Interest Rates.” In
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Friedman, Benjamin. 1981. “Debt Management Policy, Interest Rates, and Economic Activity.”
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Gale, William, and Peter Orszag. 2004. “Budget Deficits, National Saving, and Interest Rates.”
Brookings Papers on Economic Activity 2004-2: 101-210.
Greenwood, Robin, and Dimitri Vayanos. 2010. “Bond Supply and Excess Bond Returns.”
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- 42 -

Kim, Don, and Jonathan Wright. 2005. “An Arbitrage-Free Three-Factor Term Structure Modeland the Recent Behavior of Long-Term Yields and Distant-Horizon Forward Rates.” Financeand Economics Discussion Series No. 2005-33, Board of Governors of the Federal Reserve
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- 43 Appendix: Experiences of Other Countries with Large-Scale Asset Purchases

Central banks in Japan and the United Kingdom also have engaged in large-scalepurchases of longer-term assets to provide greater monetary stimulus at times when theconventional monetary policy interest rate was close to zero.56 The effects on longer-term yields
in Japan appear to have been small, reflecting the smaller scale of the purchases and the shorter
maturities purchased. In the United Kingdom, where the purchases were of a similar scale andmaturity to those in the United States, the effects on longer-term yields have been similar to
those in the United States.
Japan, 2001-06
In March 2001, the Bank of Japan (BOJ) introduced the Quantitative Easing Policy(QEP) to fight deflation. The main element of QEP was to supply banks with more thansufficient liquidity to keep the overnight interest rate at zero and thus to encourage bank lending.
A secondary element of QEP was a commitment to maintain zero interest rates until the core
consumer price inflation rate was sustainably above zero. Purchases of Japanese government
bonds (JGBs) were a tertiary element of QEP, but the BOJ did not claim that purchases of JGBs
would reduce longer-term interest rates. Rather, JGBs were viewed as an appropriate andconvenient asset for the BOJ to buy in order to supply banks with liquidity.
Ugai (2007) reports that studies of the portfolio balance effect of JGB purchases under
QEP find either small or insignificant effects on longer-term interest rates, including on
corporate bonds. Bernanke, Reinhart, and Sack (2004) also report only a small effect of news
56

In May 2009, the European Central Bank (ECB) announced plans to purchase €60 billion of covered bonds, whichhave a range of maturities. Relative to euro-area GDP, this program is about one-twentieth the size of the US and
UK asset purchase programs and its effects on longer-term interest rates are likely to be very small. In May 2010,
the ECB announced plans to purchase sovereign bonds of its member countries in order to improve market depth
and liquidity. The program was not aimed at lowering interest rates in general and planned purchase amounts havenot been announced.

- 44 about JGB purchases on longer-term yields. Relatively small effects on yields probably reflectthat the JGB purchases were not large as a share of GDP and that they were skewed toward theshortest residual maturities. According to Ugai (2007), the peak increase in BOJ holdings of
JGBs under the QEP was about 4 percent of GDP, considerably less than the 12 percent of GDP
increase in Federal Reserve holdings under the LSAPs. McCauley and Ueda (2009) show thatthe additional BOJ purchases were mainly seasoned JGBs with very short residual maturities; theaverage maturity of the BOJ’s holdings of JGBs fell from more than five years to less than four
years under QEP.57 Moreover, the Ministry of Finance increased the average maturity of newly
issued JGBs from 5 years in 2001 to 6½ years in 2005, further offsetting any effect of QEP on
longer-term bond yields.
United Kingdom, 2009-present
On February 11, 2009, Governor King of the Bank of England (BOE) stated at a press
conference that “further easing in monetary policy may well be required.” At that time the
BOE’s policy interest rate target was 1 percent. When asked about the scope for further easing
so close to the zero lower bound, King said “we will be moving to a world in which we will bebuying a range of assets, but certainly including gilts.” 58 On March 5, the BOE lowered its
policy rate target to 0.5 percent and announced plans to purchase £75 billion in assets, mainly
gilts with residual maturities between 5 and 25 years. On May 7 the program was expanded to£125 billion. On August 6 it was expanded to £175 billion. On November 5 it was expanded to£200 billion. On February 4, 2010, after the £200 billion target was reached, the BOE said it

57

Total BOJ holdings of JGBs increased about 45 percent from 2001 to 2005. If redemptions on the initial holdings
are assumed to be replaced with JGBs of sufficient maturity to hold the average maturity of those holdings constant,then the additional JGB purchases under QEP would have had an average maturity of less than one year.
58
Joyce, et al. (2010, p. 12).

- 45 would cease additional purchases but would continue to monitor the appropriate scale of the
program in light of the economic outlook.
The BOE gilt purchases, at 14 percent of UK GDP, were similar in scale to the Federal
Reserve LSAPs, at 12 percent of US GDP. According to Table B in Joyce et al. (2010), theaverage yield on 5- to 25-year gilts fell 100 basis points in total during two-day windows
surrounding the six announcement dates noted above. That decline is strikingly similar to the106 basis point decline in US 10-year Treasury yields (using two-day windows around thebaseline event set) shown in Chart 7 of this paper. In both the UK and US event studies, yields
on 1-year and 2-year bonds fell very little, suggesting that expectations about the future policy
interest rate were not responsible for most of the decline in longer-term yields.
Over the six announcement dates, UK investment-grade corporate yields fell 70 basis
points and UK speculative-grade corporate yields fell 150 basis points. These declines arebroadly comparable to the declines on similar classes of corporate bonds in the United Statesaround the US event dates. One puzzling difference between the US and UK experiences is that
10-year swap rates fell only 10 basis points in the UK event windows whereas they fell 100 basis
points in the US event windows.59

Joyce, Michael, Ana Lasaosa, Ibrahim Stevens, and Matthew Tong. 2010. “The Financial
Market Impact of Quantitative Easing.” Bank of England Working Paper No. 393.
McCauley, Robert, and Kazuo Ueda. 2009. “Government Debt Management at Low Interest
Rates.” BIS Quarterly Review, June: 35-51.
Ugai, Hiroshi. 2007. “Effects of the Quantitative Easing Policy: A Survey of Empirical
Analyses.” Bank of Japan Monetary and Economic Studies, March: 1-48.

59

The UK swap rates in Joyce et al. are linked to the sterling overnight index average (SONIA) rate whereas the US
swap rates in this paper are linked to the 3-month Libor. US 10-year swap rates based on the overnight federal
funds rate fell 50 basis point in two-day windows around our baseline event dates.