Evidence on the Portfolio Balance Channel of Quantitative Easing

Federal Reserve Bank of St. Louis Working Paper Series No. 2012-015A

33 Pages Posted: 16 Jun 2012 Last revised: 6 Nov 2012

See all articles by Daniel L. Thornton

Daniel L. Thornton

Federal Reserve Bank of St. Louis - Research Division

Date Written: June 6, 2012

Abstract

With its interest rate instrument at the zero lower bound, the Federal Open Market Committee has turned to unconventional methods to stimulate economic growth and increase employment. Prominent among these is quantitative easing (QE) — the purchase of a large quantity of longer-term debt. Policymakers and analysts have argued that QE works through the so-called portfolio balance channel: it reduces long-term yields by reducing the term premium investors require to hold long-dated securities. I present several reasons to be skeptical of the theoretical foundations of this portfolio balance channel and offer several arguments for why the effect of QE might be relatively small even if it is theoretically valid. Consistent with these arguments, an empirical analysis using a variety of interest rate variables and public debt supply measures used in the literature finds essentially no support for the portfolio balance channel.

Keywords: quantitative easing, portfolio balance channel, unconventional monetary policy, zero lower bound, term premium

JEL Classification: E52, E58, E43, E44

Suggested Citation

Thornton, Daniel L., Evidence on the Portfolio Balance Channel of Quantitative Easing (June 6, 2012). Federal Reserve Bank of St. Louis Working Paper Series No. 2012-015A, Available at SSRN: https://ssrn.com/abstract=2084260 or http://dx.doi.org/10.2139/ssrn.2084260

Daniel L. Thornton (Contact Author)

Federal Reserve Bank of St. Louis - Research Division ( email )

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HOME PAGE: http://research.stlouisfed.org/econ/thornton/

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