Elizabeth C. Klee

Analyzing Federal Reserve Asset Purchases: From Whom Does the Fed Buy?

Asset purchases have become an important monetary policy tool of the Federal Reserve in recent years. To date, most studies of the Federal Reserve’s asset purchases have tried to measure the interest rate effects of the purchases, and several provide evidence that these purchases do have important effects on longer-term market interest rates. The theory of how asset purchases work, however, is less well developed. Some of the empirical studies point to “preferred habitat” models in which investors do not have the same objectives, and therefore prefer to hold different types and maturities of securities. To study this more closely, we exploit Flow of Funds data to assess the types of investors that are selling to the Federal Reserve and their portfolio adjustment after these sales, which could provide a view to the plausibility of preferred habitat models and the transmission of unconventional monetary policy across asset markets. We find that the Federal Reserve is ultimately buying from only a handful of investor types, primarily households (which includes hedge funds), with a different reaction to changes in Federal Reserve holdings of longer-term versus shorter-term assets. Although not evident for all investors, the key participants are shown to rebalance their portfolios toward more risky assets during this period. These results can be interpreted as supporting, at least in part, the preferred habit theory and the view that the monetary policy transmission is working across asset markets.

Expectations About the Federal Reserve's Balance Sheet and the Term Structure of Interest Rates

This paper provides a systematic assessment of the effect of the Federal Reserves asset purchase programs on Treasury yields, with particular emphasis on the role of market expectations about the evolution of the Federal Reserves balance sheet and of interest rates on the impact of the programs. We construct measures of such market expectations based on Blue Chip survey forecasts, Congressional Budget Office projections, and information from formal FOMC communications. Those measures are combined with a no-arbitrage term structure model, in which yields are driven by current and expected future private Treasury holdings, among other factors. This approach allows us to provide estimates of the term premium effects of the asset programs both at the time of the announcements and in the future as expectations about the economy and the Federal Reserves balance sheet evolve. Our results suggest that the program with the largest initial impact on the ten year Treasury yield as the first purchase program, which is estimated to have held down rates by about 40 basis points in early 2009, and the initial maturity extension program had the second largest estimated impact at its inception, pushing rates down by about 20 basis points in late 2011. Currently, we estimate all programs combined are holding down the 10-year yield by about 65 basis points, of which about one-third is attributable to the first purchase program.

Operational outages and aggregate uncertainty in the federal funds market.

This paper uses operational problems at depository institutions in sending Fedwire payments as a proxy for aggregate uncertainty in end-of-day Fed account positions and then examines funds market behavior on those days. The results suggest that increased uncertainty is associated with a deviation of the federal funds rate from the Federal Open Market Committees (FOMCs) target rate; the magnitude depends on the severity of the difficulty, the payment volume of the affected participant, and the time of day. The intraday standard deviation of the federal funds rate is also affected by operational outages. Moreover, extensions to Fedwire are more likely on days with possible outages, and discount window borrowing picks up on these days as well.

Arbitrage, Liquidity and Exit: The Repo and Federal Funds Markets Before, During, and Emerging from the Financial Crisis

This paper examines the link between the federal funds and repo markets, before, during, and emerging from the financial crisis that began in August 2007. In particular, the paper investigates the initial transmission of monetary policy to closely related money markets, pricing of risk, and liquidity effects, and then shows how these could interact if the Federal Reserve removes the substantial amount of liquidity currently in the federal funds market. The results suggest that pass-through from the federal funds rate to the repo deteriorated somewhat during the zero lower bound period, likely due to limits to arbitrage and idiosyncratic market factors. In addition, during the early part of the crisis, the pricing of federal funds, which are unsecured loans, indicated a marked jump in perceived credit risk. Moreover, the liquidity effect for the federal funds rate, or the change in the federal funds rate associated with an exogenous change in reserve balances, weakened greatly with the increase in supply of these balances over the crisis, implying a non-linear demand for federal funds. Using these analyses, the paper then shows simulations of the dynamic effects and balance sheet mechanics of liquidity draining on the federal funds and repo rates -- a tool that might be used in an exit strategy to tighten monetary policy.

Paper or plastic? the effect of time on the use of check and debit cards at grocery stores

Time is a significant cost of conducting transactions, and theoretical models predict that transactions costs significantly affect the type of media of exchange buyers use. However, there is little empirical work documenting the magnitude of this effect. This paper uses grocery store scanner data to examine how time affects consumer choices of checks and debit cards. On average, check transactions take thirty percent longer than debit card transactions. This time difference is a significant factor in the choice to use a debit card over a check and offers empirical evidence for transactions costs affecting the use of media of exchange.

The First Line of Defense: The Discount Window During the Early Stages of the Financial Crisis

This paper develops a theoretical model of trading in the federal funds market that captures characteristics of discount window borrowing and the federal funds market during the first year of the financial crisis, including the narrowing of the spread between the discount rate and the target rate; the increased incidence of high-rate trading; and the decline in participation in the federal funds market. The model shows that differences in stigma of borrowing from the discount window across banks can cause the federal funds rate to rise, even when the spread between the discount rate and the target rate narrows. The model is then evaluated using both aggregate and institution-level data. The data suggest that in aggregate, federal funds volume brokered at rates above the primary credit rate and discount window borrowing both increased during the first stages of the crisis. Bank-level data suggest that institutions that went to the discount window paid lower rates in the federal funds market than banks that did not. This effect became stronger as the spread between the primary credit rate and the target rate narrowed, coincident with the intensification of the financial crisis.

Comparisons of the Incentive for Insolvency under Different Legal Regimes

Abstract This paper compares the effects of joint and several liability on capital and production decisions with the effects of several‐only liability in the context of hazardous‐waste generation. Our main result shows that increased potential liability causes firms to decrease asset exposure but may also lead firms to create less waste. First, we find that both several‐only and joint and several liability induce firms to go bankrupt more often and create more waste than is socially optimal. Then we find that, for a given level of funds, joint and several liability induces firms to go bankrupt more often and to create more waste than does several‐only liability. This implies that society will be responsible for a larger share of cleanup under joint and several liability than under several‐only liability. Finally, we show that firms with potentially higher liabilities for cleanup will raise fewer funds, creating “smaller” firms and thus the possibility of less waste generated overall.

The Federal Reserve's Portfolio and its Effect on Interest Rates

We explore the historical composition of the Federal Reserves Treasury portfolio and its effect on Treasury yields. Using data from 1985 to 2016, we show that the divergence of the composition of the Federal Reserves portfolio from overall Treasury securities outstanding is associated with a statistically significant effect on interest rates. In aggregate, when the Federal Reserves portfolio has shorter maturity than overall Treasury debt outstanding, measures of the term premium are higher at all horizons; likewise, when the Federal Reserves portfolio has longer maturity, term premiums are lower. In addition, at the individual security level, differences in Federal Reserve holdings from overall Treasury debt outstanding are correlated with measures of pricing errors and liquidity premiums. We discuss the mechanism for this effect, which could include elements of preferred-habitat theory as well as the fiscal theory of the price level.

Effects of Changing Monetary and Regulatory Policy on Overnight Money Markets

Money markets have been operating under a new monetary policy implementation framework since the Federal Reserve started paying interest on bank reserves in late 2008. The regulatory environment has also evolved substantially over this period. We develop and test hypotheses regarding the effects of changes in the monetary and regulatory policy on dynamics of key overnight funding markets. We find that the federal funds rate continued to provide an anchor, albeit weaker, for unsecured funding rates amid substantial decline in activity and changing composition of trades, while its transmission to the repo market had been hampered. The overnight reverse repurchase (ON RRP) operations that started in late 2013 contributed to stronger co-movement among overnight funding rates and markedly reduced their volatility. The change in the FDIC assessment fees and Basel III leverage ratio regulations have exacerbated financial-reporting-day effects in unsecured markets. In contrast, consistent with lower dealer leverage in the post-crisis period, such effects have weakened in the repo market, especially after the inception of the ON RRP facility. Finally, superabundant bank reserves appear to have significantly diminished the effects of reserve-maintenance on the money market rates.

Dynamics of Overnight Money Markets: What Has Changed at the Zero Lower Bound?

In this note we provide a comparative analysis of overnight money market dynamics before the crisis and after the target federal funds rate (FFR) has been lowered to the zero lower bound (ZLB).