Purchasing long-term Treasuries “is still on the table” as a policy option, Bullard said, answering an audience question.  The debate over buying Treasuries has continued for two meetings of the FOMC and may continue through the spring, Bullard told reporters.   “For now we want to see how other” emergency Fed programs designed to increase credit “work out,” he said.

As reported by Bloomberg News

I should also note that, as conditions warrant, we will be expanding existing programs. In addition, we are considering the purchase of longer-term Treasury securities, if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets.

Evans later expanded on this point to reporters:

Evans said the Fed should wait to see the results of its emergency credit programs before deciding whether to buy long- term Treasuries to lower yields. "There is still a lot of work that needs to come on line," Evans told reporters. "Frankly, for myself, I want to see how that is playing out."

As reported by Bloomberg News

The Federal Reserve's third set of policy tools for supporting the functioning of credit markets involves the purchase of longer-term securities for the Fed's portfolio.  For example, we recently announced plans to purchase up to $100 billion of the debt of government-sponsored enterprises (GSEs), including Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, and up to $500 billion in agency-guaranteed mortgage-backed securities (MBS) by midyear.  The objective of these purchases is to lower mortgage rates, thereby supporting housing activity and the broader economy.

Note:  In his previous reference to the agency and MBS purchase program on January 13, Bernanke also mentioned the possibility of buying long-dated Treasury securities.  That option was omitted from this testimony.

In support of the housing sector, the Fed created a $600 billion program to purchase agency debt and agency-insured mortgage-backed securities. Yields on mortgage-backed securities and 30-year fixed-rate mortgages fell substantially right after the program was announced, and these rates fell again when the first purchases were made in January.  The Fed has developed another very promising program jointly with the Treasury to help restore functioning in other impaired financial markets, called the Term Asset-Backed Securities Loan Facility (TALF)...

Note:  In her previous reference to the agency and MBS purchase program on January 4, Yellen also mentioned the possibility of buying long-dated Treasury securities.  That option was omitted from this speech.

"If you compare buying Treasuries to a targeted credit program, the targeted credit program will result in probably lower interest rates in the targeted sector, but higher interest rates in the other sectors."

...

"I would have preferred a program of buying Treasuries over targeted credit programs like the Term Asset-Backed Securities Lending Facility", Lacker said. He said he would not be opposed to the purchase of long-term Treasury securities such as 10-year notes and 30-year bonds.

As reported by Bloomberg News

Other than policies tied to current and expected future values of the overnight interest rate, the Federal Reserve has--and indeed, has been actively using--a range of policy tools to provide direct support to credit markets and thus to the broader economy.  As I will elaborate, I find it useful to divide these tools into three groups...

The first set of tools, which are closely tied to the central bank's traditional role as the lender of last resort, involve the provision of short-term liquidity to sound financial institutions.  Over the course of the crisis, the Fed has taken a number of extraordinary actions to ensure that financial institutions have adequate access to short-term credit.  These actions include creating new facilities for auctioning credit and making primary securities dealers, as well as banks, eligible to borrow at the Fed's discount window...

[T]he Federal Reserve has developed a second set of policy tools, which involve the provision of liquidity directly to borrowers and investors in key credit markets.  Notably, we have introduced facilities to purchase highly rated commercial paper at a term of three months and to provide backup liquidity for money market mutual funds...

The Federal Reserve's third set of policy tools for supporting the functioning of credit markets involves the purchase of longer-term securities for the Fed's portfolio.  For example, we recently announced plans to purchase up to $100 billion in government-sponsored enterprise (GSE) debt and up to $500 billion in GSE mortgage-backed securities over the next few quarters... The Committee is also evaluating the possibility of purchasing longer-term Treasury securities.  In determining whether to proceed with such purchases, the Committee will focus on their potential to improve conditions in private credit markets, such as mortgage markets.

...

These three sets of policy tools--lending to financial institutions, providing liquidity directly to key credit markets, and buying longer-term securities--have the common feature that each represents a use of the asset side of the Fed's balance sheet, that is, they all involve lending or the purchase of securities.  The virtue of these policies in the current context is that they allow the Federal Reserve to continue to push down interest rates and ease credit conditions in a range of markets, despite the fact that the federal funds rate is close to its zero lower bound.

Moving beyond the money markets, interventions have only just begun, and considerable scope remains for targeted asset purchases and discount window lending programs to improve the flow of credit and reduce its cost in sectors that have been severely impacted by the financial crisis. In November, the Fed announced and commenced a $600 billion program to purchase agency debt and agency-insured mortgage-backed securities. A successful initiative in this area could provide significant support to the housing sector. Scope remains for larger interventions, and in December the FOMC reiterated its readiness to expand upon these purchases "as conditions warrant." Even at this early stage, the program appears to be having an impact. For example, yields on mortgage-backed securities and 30-year fixed-rate mortgages fell substantially immediately after the program was announced. The decline in mortgage rates, which also has been affected by a decline in Treasury yields, has prompted an upsurge in refinancing activity in recent weeks. The FOMC could also expand its purchases of longer-term Treasury debt—an initiative that could lower government borrowing rates and spill over into private borrowing rates more broadly. In its December statement, the FOMC noted that it is evaluating the potential benefits of such purchases.  

Although conventional interest rate policy is constrained by the fact that nominal interest rates cannot fall below zero, the second arrow in the Federal Reserve's quiver--the provision of liquidity--remains effective. Indeed, there are several means by which the Fed could influence financial conditions through the use of its balance sheet, beyond expanding our lending to financial institutions. First, the Fed could purchase longer-term Treasury or agency securities on the open market in substantial quantities. This approach might influence the yields on these securities, thus helping to spur aggregate demand. Indeed, last week the Fed announced plans to purchase up to $100 billion in GSE debt and up to $500 billion in GSE mortgage-backed securities over the next few quarters. It is encouraging that the announcement of that action was met by a fall in mortgage interest rates.

[T]he BOJ's most recent financial statement showed that of the 68 percent of its assets held in the form of government securities, about two-thirds are long-term Japanese government bonds (JGBs)... If the Bank of Japan were to succeed in replacing deflation with a low but positive rate of inflation, its reward would likely be substantial capital losses in the value of its government bond holdings arising from the resulting increase in long-term nominal interest rates.

With such concerns in mind, BOJ officials have said that a strengthening of the Bank's capital base is needed to allow it to pursue more aggressive monetary policy easing. In fact, the BOJ recently requested that it be allowed to retain 15 percent (rather than 5 percent) of the surplus for the 2002 fiscal year that just ended to increase its capital, and the Ministry of Finance has indicated that it will approve the request. Even with this additional cushion, however, concerns on the part of the BOJ about its balance sheet are likely to remain.

The public debate over the BOJ's capital should not distract us from the underlying economics of the situation... Indeed, putting aside psychological and symbolic reasons, important as these may be in some circumstances, there appear to be only two conceivable effects of the BOJ's balance sheet position on its ability to conduct normal operations. First, if the BOJ's income were too low to support its current expenditure budget, the Bank might be forced to ask the MOF for supplemental funds, which the BOJ might fear would put its independence at risk... Second, an imaginable, though quite unlikely, possibility is that the Bank could suffer sufficient capital losses on its assets to make it unable to conduct open-market sales of securities on a scale large enough to meet its monetary policy objectives.

In short, one could make an economic case that the balance sheet of the central bank should be of marginal relevance at best to the determination of monetary policy. Rather than engage in what would probably be a heated and unproductive debate over the issue, however, I would propose instead that the Japanese government just fix the problem... I am intrigued by a simple proposal that I understand has been suggested by the Japanese Business Federation, the Nippon Keidanren. Under this proposal the Ministry of Finance would convert the fixed interest rates of the Japanese government bonds held by the Bank of Japan into floating interest rates. This "bond conversion"--actually, a fixed-floating interest rate swap--would protect the capital position of the Bank of Japan from increases in long-term interest rates and remove much of the balance sheet risk associated with open-market operations in government securities.

So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure...One approach...would be for the Fed to commit to holding the overnight rate at zero for some specified period...A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years)...Of course, if operating in relatively short-dated Treasury debt proved insufficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities, say three to six years. Yet another option would be for the Fed to use its existing authority to operate in the markets for agency debt. (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association).

Historical experience tends to support the proposition that a sufficiently determined Fed can peg or cap Treasury bond prices and yields at other than the shortest maturities. The most striking episode of bond-price pegging occurred during the years before the Federal Reserve-Treasury Accord of 1951.¹⁰ Prior to that agreement, which freed the Fed from its responsibility to fix yields on government debt, the Fed maintained a ceiling of 2-1/2 percent on long-term Treasury bonds for nearly a decade. Moreover, it simultaneously established a ceiling on the twelve-month Treasury certificate of between 7/8 percent to 1-1/4 percent and, during the first half of that period, a rate of 3/8 percent on the 90-day Treasury bill. The Fed was able to achieve these low interest rates despite a level of outstanding government debt (relative to GDP) significantly greater than we have today, as well as inflation rates substantially more variable. At times, in order to enforce these low rates, the Fed had actually to purchase the bulk of outstanding 90-day bills. Interestingly, though, the Fed enforced the 2-1/2 percent ceiling on long-term bond yields for nearly a decade without ever holding a substantial share of long-maturity bonds outstanding.¹¹ For example, the Fed held 7.0 percent of outstanding Treasury securities in 1945 and 9.2 percent in 1951 (the year of the Accord), almost entirely in the form of 90-day bills. For comparison, in 2001 the Fed held 9.7 percent of the stock of outstanding Treasury debt.

__________________________________

11. See Eichengreen and Garber (1991) and Toma (1992) for descriptions and analyses of the pre-Accord period. Both articles conclude that the Fed's commitment to low inflation helped convince investors to hold long-term bonds at low rates in the 1940s and 1950s. (A similar dynamic would work in the Fed's favor today.) The rate-pegging policy finally collapsed because the money creation associated with buying Treasury securities was generating inflationary pressures. Of course, in a deflationary situation, generating inflationary pressure is precisely what the policy is trying to accomplish.

An episode apparently less favorable to the view that the Fed can manipulate Treasury yields was the so-called Operation Twist of the 1960s, during which an attempt was made to raise short-term yields and lower long-term yields simultaneously by selling at the short end and buying at the long end. Academic opinion on the effectiveness of Operation Twist is divided. In any case, this episode was rather small in scale, did not involve explicit announcement of target rates, and occurred when interest rates were not close to zero.

Unorthodox monetary policy may work, but it obviously would have to be through channels other than reducing short-term interest rates since they are already at zero. Those channels might include reducing expected short-term rates by tilting down long-term rates, or reducing term or risk premiums in long-term rates. The latter also would tend to reduce long-term rates and exchange rates as well.

Pumping up the monetary base by itself would be unlikely to be effective in doing either of these things, that is, reducing short-term rate expectations or term and risk premiums. Such increases in the base would tend to go into excess reserves and there is no obvious reason why that would change expectations about future rates. Tilting open market operations to a limited degree toward bonds or foreign exchange also is not likely to do much. Studies show that modest changes in the supply of bonds, Operation Twist kinds of things, do not have much effect on bond yields. Sterilized intervention, which is what in effect such foreign exchange buying would be, also does not do much. However, massive purchases of bonds or massive intervention might. The Federal Reserve did set the rate on government bonds during World War II. If a central bank were willing to purchase all the supply of government bonds, it could set the bond rate again, and presumably this would feed through to corporate borrowing rates as well. So, there are extreme policies involving massive purchases that should work in lowering term premiums and risk premiums.

Presented as part of the staff briefing at the June 30-July 1 FOMC meeting in 1998.

Now, what is interesting here is that there has been extensive literature on Operation Twist, and my recollection is that it's pretty mixed. No one has been able to confirm that there is a significant supply-side effect occurring in that particular context. On the other hand, there is also evidence, mainly in the recent period, that the Treasury rate is higher relative to private instruments than it otherwise would be, from which one assumes that there is a supply-side effect. So, I would say that there is no really strong analytical evidence that confirms this one way or the other. And what I find a little surprising is how strongly the market responded to Brady's initial [remarks on reducing Treasury long-bond issuance]; I think rates moved down 5 basis points at the long end of the market.