Treasury Market Frictions and Quantitative Easing

Abstract

This paper describes the US Treasury Department auction process and discusses the theoretical and empirical supports for using Treasury auction data to infer supply effects of Treasury securities. As the mechanics of Treasury auctions and the Federal Reserve’s implementation of quantitative easing are similar, this research adds to our understanding of the effects of quantitative easing by inferring its potential supply effects from the supply effects of Treasury auctions. The inferred estimate is comparable to the findings of prior studies by D’Amico and King (2013) and others. Furthermore, the auction data implies time-varying supply effects that were stronger during the period of heightened market frictions due to the 2007-2008 financial crisis. This result suggests that as a financial market normalizes and financial frictions are reduced, the supply effects of quantitative easing wane. Thus, as markets return to normal after financial crises, quantitative policies to keep interest rates low require progressively higher amount of purchases.