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
Date Written: June 6, 2012
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: Suggested Citation