Analysis of the Federal Reserve’s Quantitative Easing Program: Asset Price, Yield Curve, & Liquidity Effects

Abstract

We study the Federal Reserve’s Quantitative Easing Program in order to provide a well-rounded understanding of both the past and potential future effects of this uncon- ventional monetary policy. We highlight empirically the complexity of the interaction between the Federal Reserve’s balance sheet and asset prices in equity, fixed income, and currency markets. Building off of the arbitrage-free affine term structure method- ology of Jarrow & Li (2014), we model the impact of QE3 on the yield curve, using a Kalman filter to tease out the theoretical short rate before applying large-trader methodology to identify the impact of the Federal Reserve’s purchases on forward yields. We identify an 89 basis point impact on 10 year yields as a result of QE3; this is consistent with related literature. Additionally, we study the runoff of the Fed’s balance sheet and its impact on the liquidity of the market at large, building off of Bräuning (2017), and document a relatively strong relationship between short term interest rate spreads and changes in reserves, after seasonal adjustment via discrete Fourier Transform. Using this relationship we forecast a 20 basis point widening in the Overnight Indexed Swap (OIS) spread over the Federal Funds target rate at the conclusion of balance sheet renormalization in 2019. Using a macroeconomic model developed by Calvo (2016) that combines Kiyotaki-Moore (1997) credit cycles with financial frictions, we motivate the importance of persistent liquidity in the zero lower bound rate environment.