Abstract
In this paper, I evaluate a potential cost of large-scale asset programs, also known as quantitative easing (QE). Specifically, I assess the effect of ongoing Federal Reserve mortgage-backed security (MBS) purchases on liquidity conditions in the MBS market. Considering several indicators of liquidity and market functioning, I show that Federal Reserve MBS purchases negatively affected volumes, trade sizes, and implied financing rates in dollar roll transactions. Additionally, I present some evidence that bid-ask spreads briefly widened as a result of Federal Reserve purchases that occurred early on in the “QE3” program. Notably, the adverse liquidity effects of Federal Reserve purchases appear to be most evident shortly after new purchase programs are initiated. However, the magnitude of the liquidity effects resulting from Federal Reserve purchase operations is quite modest, short-lived, or both. Finally, I demonstrate that the apparent liquidity-impairing effects of Federal Reserve MBS purchases did not translate into a deterioration of price discovery in the MBS market.
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