NY Fed's Brian Sack on Asset Prices and Balance Sheet Policy 10/4

Brian Sack, Executive Vice President of the New York Federal Reserve, gave a speech at a CFA Institute Fixed Income Management Conference on 10/4. He made interesting remarks about asset prices and balance sheet policy. People should understand the forces at work here.
"The effect of asset purchases on the economy remains a point of ongoing debate, with some uncertainty about the channels through which such purchases operate and the magnitude of those effects. My own perspective is aligned with the view expressed by Chairman Bernanke in Jackson Hole—that the effects arise primarily through a portfolio balance channel. Under that view, our asset holdings keep longer-term interest rates lower than otherwise by reducing the aggregate amount of risk that the private markets have to bear. In particular, by purchasing longer-term securities, the Federal Reserve removes duration risk from the market, which should help to reduce the term premium that investors demand for holding longer-term securities. That effect should in turn boost other asset prices, as those investors displaced by the Fed’s purchases would likely seek to hold alternative types of securities."

"Some research studies have estimated that the effects of the earlier expansion of our securities holdings by just over $1.5 trillion lowered longer-term Treasury yields by about 50 basis points through this portfolio balance channel. These effects on Treasury yields appear to have been transmitted into lower rates on private credit instruments and higher asset prices more broadly."

"Some observers have argued that balance sheet changes, even if they influence longer-term interest rates, will not affect the economy because the transmission mechanism is broken. This point is overstated in my view. It is true that certain aspects of the transmission mechanism are clogged because of the credit constraints facing some households and businesses, and it is true that monetary policy cannot directly target those parties that are the most constrained. Nevertheless, balance sheet policy can still lower longer-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be. It seems highly unlikely that the economy is completely insensitive to borrowing costs and wealth, or to other changes in broad financial conditions."
Source: Managing the Federal Reserve's Balance Sheet

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