In a paper presented Friday morning at the Kansas City Fed's Jackson Hole economic symposium, Arvind Krishnamurthy and Annette Vissing-Jorgensen look at how the trillions of dollars in bond purchases by the Federal Reserve affect markets and the economy. And they find, in part, that one major component of the strategy has done little to help economic growth and may have made Americans worse off.
The Fed has been buying both longer-term U.S. Treasury bonds ($1.9 trillion and counting) and mortgage-backed securities ($1.3 trillion and counting), using newly created money. But there has been a simmering debate over how and whether the purchases have much effect. Krishnamurthy and Vissing-Jorgensen (economists at Northwestern University and the University of California-Berkeley, respectively) find that there's actually an important difference between the two categories of purchases, which commentators lump together as quantitative easing.
The authors view one of the significant ways that these purchases affect the economy through a “scarcity effect.” When the Fed buys billions of mortgage bonds, the pair finds, other investors who want to hold some amount of the securities have to pay more for them, pushing down the rates on the bonds, and by extension lowering the costs for homebuyers. By the researchers' math, the Fed’s first round of QE, back in 2009, lowered 30-year mortage-backed securities yields by 1.07 percentage points; its 2011 efforts to buy more of the securities lowered them 0.23 percent; and the QE3 policy now underway contributed another 0.16 percent.
“The scarcity . . . generates incentives for banks to originate more loans and relieve the shortage of the current coupon MBS,” they write.
They find similar impacts in terms of lower rates for Treaury bonds, but they argue that, in contrast to MBS, these haven’t helped the real economy. In effect, they argue, Treasury bonds fulfill a unique role at the bedrock of the financial system, allowing investors an ultra-safe place to park money that can be readily used as collateral. When the Fed buys up a big chunk of Treasury bonds, fewer other investors can enjoy that benefit.
That would be fine if those investors could just shift into near-substitutes, like highly rated corporate bonds, which could lower borrowing costs for big companies and thus encourage them to invest. But the problem is that there aren't that many AAA-rated companies, so those benefits have not percolated through the economy to the degree one might hope.
“While Treasury [asset purchases] lower long-term Treasury yields, they have ambiguous welfare effects,” the authors write. “The primary beneficial effect of these purchases results from a spillover that raises the prices of private sector safe bonds (which are substitutes for safe Treasury bonds). However, due to the private sector’s limited ability to produce long-term safe assets (i.e. AAA corporate bonds are few), these beneficial economic effects are limited. Moreover, since the safety premium on Treasury bonds stem from the economic benefits they provide to investors, by reducing the supply of Treasury bonds, the economy is deprived of extremely safe and liquid assets and welfare is reduced.”
There is an irony here. If this analysis is right, the economic benefits of QE come from MBS purchases, not Treasuries. Yet the Fed itself prefers not to be in the role of favoring one sector (housing) over others, and so many officials there lean toward focusing heavily, or even only, on the less-effective Treasury bond market.