Table 1 provides a summary of various studies' estimated effects of these programs on the term premium on 10-year Treasury securities. For example, the decline in 10-year Treasury yields associated with the first purchase program is estimated to have been as large as 100 basis points. The documented effects associated with subsequent programs are generally smaller. These results raise the question of whether the marginal effect of asset purchases has declined over time. While that question is a valid one, our conclusion is that asset purchases over more recent years have provided meaningful stimulus to the economy, and continue to do so.

Although individual estimates differ, this analysis typically suggests that $600 billion of Fed asset purchases lowers the yield on 10-year Treasury notes by around 15 to 25 basis points.1 To put that in perspective, that’s roughly the same size move in longer-term yields one would expect from a cut in the federal funds rate of ¾ to 1 percentage point.

Nevertheless, I don’t see LSAPs as being part of the FOMC’s toolkit once we leave the zero bound behind us. We’re still much less certain about their effects than we are about the effects of changes in the federal funds rate. According to Brainard’s classic analysis, the more uncertain you are about the effects of a policy tool, the more cautiously you should use it. Instead, you should rely more on other instruments in which you have greater confidence…

That said, I expect that the explicit link between future policy actions and specific numerical thresholds, as in the recent FOMC statements, will not be a regular aspect of forward guidance, at least when the federal funds rate is not constrained by the zero lower bound… [S]uch communication is difficult to get right and comes with the risk of oversimplifying and confusing rather than adding clarity. Therefore, in normal times, a more nuanced approach to policy communication will likely be warranted. I see forward guidance typically being of a more qualitative nature, highlighting the key economic factors that will affect future policy actions. Of course, if we again find ourselves in a situation where conventional policy has reached its limits, then we will have the ability to return to more explicit forward policy guidance to provide additional monetary stimulus.

The evidence to date provides support for the view that financial markets are segmented and that asset purchase programs affect interest rates and other asset prices. There have been numerous studies of the effects of our asset purchases on longer-term interest rates.3 This analysis suggests that each $100 billion of asset purchases lowers the yield on 10-year Treasury notes by around 3 to 4 basis points, that is between 0.03 to 0.04 percentage point. That might not sound like much. But consider the Fed’s so-called QE2 program in 2010-11 that totaled $600 billion of purchases. According to estimates, that program lowered 10-year yields by about 20 basis points. That’s about the same amount that the 10-year Treasury yield typically falls in response to a cut in the federal funds rate of ¾ to 1 percentage point, which is a big change.4 Applying the same logic to the current, much larger, asset purchase program, the implied reduction in longer-term interest rates is roughly 40 to 50 basis points.

We just saw a case study of how changes in expectations of the Fed’s asset purchases affect longer-term interest rates and financial conditions more broadly. The FOMC’s announcement on September 18 that it would not change the pace of asset purchases appeared to cause financial market participants to expect that the Fed would purchase more assets in the future than they had previously believed. As a result, in the minutes following the announcement, the yield on the 10-year Treasury note fell by 18 basis points. The effects didn’t stop there. The stock market rose about 1¼ percent and the value of the dollar against the euro fell by around 1 percent.

Investors’ disagreement and uncertainty about the overall stance of monetary policy will reflect their views on the future evolution of both the federal funds rate and the SOMA portfolio. One way to get a sense of the overall level of policy uncertainty is to convert the SOMA portfolio into “fed funds equivalents.”[8] With this translation, it is possible to estimate the hypothetical level of the federal funds rate that would provide a similar amount of monetary policy accommodation as both the actual level of the federal funds rate and the size of the SOMA portfolio.

[8] Fed funds equivalents are calculated by comparing the change in the 10-year Treasury yield due to asset purchases to the change that historically occurred following movements in the target federal funds rate. This is a simple framework, so the uncertainty around this measure is likely large

Federal Reserve Bank of Boston staff use two different models to estimate the impact of asset purchases on the economy. One explicitly articulates household and business behaviors and the other is a purely statistical model. Reassuringly, both models give similar results. Our best estimate implies roughly a one-quarter-point decrease in the unemployment rate for a $500 billion asset-purchase program.

By this estimate, the benefits of the large-scale asset purchase (LSAP) program include almost 400,000 additional workers employed for every $500 billion in purchased assets (which earn a return while on the Fed’s books), returning to our inflation target somewhat more quickly, and a somewhat better debt-to-GDP ratio as a result of the lower interest rates and improved GDP and revenue growth. While these estimates are model dependent, and are clearly subject to estimation error, they are broadly consistent with other studies – and with the growth in asset prices and the expansion of the interest-sensitive components of GDP seen since last September.

[T]o capture the benefits of the LSAP you need a fuller model. One of the models currently used by the Federal Reserve Bank of Boston provides a relatively conservative estimate of the economic benefits of a hypothetical additional $750 billion LSAP. Based on historical experience, the model implies that such a purchase would lower long-term rates by 20 to 25 basis points, relative to not making the additional purchases. The impact of this large a reduction in long-term rates is a cumulative gain in real GDP, relative to the base, of 1.6 percent or $260 billion. In our model such a purchase also results in a decline in the unemployment rate of 0.25 percent or 400,000 jobs. Some of the models we run provide a larger impact to such purchases.

For example, studies have found that the $1.7 trillion in purchases of Treasury and agency securities under the first LSAP program reduced the yield on 10-year Treasury securities by between 40 and 110 basis points. The $600 billion in Treasury purchases under the second LSAP program has been credited with lowering 10-year yields by an additional 15 to 45 basis points.¹²Three studies considering the cumulative influence of all the Federal Reserve's asset purchases, including those made under the MEP, found total effects between 80 and 120 basis points on the 10-year Treasury yield.¹³ These effects are economically meaningful.

Other evidence suggests that this downward pressure has had favorable spillover effects on other financial markets, leading to lower long-term borrowing costs for households and firms, higher equity valuations, and other improvements in financial conditions that in turn have supported consumption, investment, and net exports. Because the term premium effect depends on both the Federal Reserve's current and expected future asset holdings, most of this effect--without further actions--will likely wane over the next few years as the effect depends less and less on the current elevated level of the balance sheet and increasingly on the level of holdings during and after the normalization of our portfolio.

Some of the staff work that calibrates the economic impact of the Federal Reserve’s balance sheet policies assumes that the effects on yields and financial conditions are driven by the amount of ten-year equivalents that the Fed takes into its portfolio.

By that metric, the effect of the Maturity Extension Program is about equal in size to that of the large-scale asset purchase program that ended in June of this year (what we have referred to as LSAP2). This fact was highlighted in a recent post to the Liberty Street Economics blog.⁴ In both cases, the effect of the program was to remove about $400 billion of 10-year equivalents from the market.

Based on our experience with Operation Twist in the 1960s and with last year’s QE2, the reduction in long-term rates from our actions in September is likely to be less than 20 basis points for the 10-year Treasury yield, which is currently only 2 percent. The pass-through to the rates at which consumers and businesses actually borrow is likely to be considerably less. Thus, I am skeptical that this will do much to spur businesses to hire or consumers to spend, given the ongoing adjustments occurring in the economy and the uncertainties posed by the fiscal challenges both here and abroad.

SEN. CASEY: I have two questions on that. Number one is, as a result of that -- the implementation of that policy, how much of a decline in long- term interest rates would you expect?

MR. BERNANKE: Well, we would expect something on the order of 20 basis points, approximately. We see this as being roughly approximately equal to something like a 50-basis-point cut in the federal funds rate. In that respect, it's a significant step but not a game changer in some respects.

SEN. CASEY: And in terms of the intended or hoped-for economic boost from that, what's your sense of that? How can you assess that?

MR. BERNANKE: Well, we think this is a meaningful but not an enormous support to the economy. I think it will provide some additional monetary policy accommodation. It should help somewhat on job creation and growth. It's particularly important now that the economy is close -- the recovery is close to faltering. We need to make sure that the recovery continues and doesn't drop back and that the unemployment rate continues to fall downward.

So I don't have a precise number, but I would just put it as a moderate support, not something that is expected to radically change the picture, but what should be helpful both in keeping prices near the price stability level but also providing some support for growth.

From the Q&A session

I dissented from these decisions because I believe that they will do little to improve the near-term prospects for economic growth or employment and they do pose risks. Policy actions should never be considered free and should be evaluated based on the costs and benefits. Based on our experience with Operation Twist in the 1960s and with last year’s QE2, the reduction in long-term rates is likely to be less than 20 basis points for the 10-year Treasury yield, which is currently only 2 percent. The pass-through to the rates at which consumers and businesses actually borrow is likely to be much less. Thus, I am skeptical that this will do much to spur businesses to hire or consumers to spend, given the ongoing structural adjustments occurring in the economy and the uncertainties posed by the fiscal challenges both here and abroad.

The estimated effects [of LSAPs on asset prices] typically lie in the neighborhood of 15 to 20 basis points. Generally, the estimates are reasonably precise. Although some might argue that 15 to 20 basis points is small, keep in mind that the typical response of the 10-year Treasury yield to a 75 basis point cut in the federal funds rate is also about 15 to 20 basis points. I’ve never heard anyone argue that a 75 basis point cut in the funds rate is small potatoes!

The standard response to {a projected 0.7% increase} in core PCE inflation would be to raise the target interest rate by a larger amount—that is, by at least 70 basis points. For example, the widely known rules associated with John Taylor of Stanford University would recommend that the response should be to raise the target interest rate by 1.5 times the increase in core inflation—that is, by 105 basis points...