This Selected Issues paper on United States 2012 Article IV Consultation discusses rebound of manufacturing production. The U.S. share in global manufacturing production declined through most of the past three decades, but it has stabilized since the Great Recession. It currently represents about 20 percent of global manufacturing value added. Interestingly, after a sharp increase during most of the previous decade, China’s share in global manufacturing has also stabilized since the Great Recession, at a level similar to that of the United States. The notion of a manufacturing renaissance has been fuelled partly by the rebound in production since the end of the Great Recession.


This Selected Issues paper on United States 2012 Article IV Consultation discusses rebound of manufacturing production. The U.S. share in global manufacturing production declined through most of the past three decades, but it has stabilized since the Great Recession. It currently represents about 20 percent of global manufacturing value added. Interestingly, after a sharp increase during most of the previous decade, China’s share in global manufacturing has also stabilized since the Great Recession, at a level similar to that of the United States. The notion of a manufacturing renaissance has been fuelled partly by the rebound in production since the end of the Great Recession.

Exiting from Unconventional Monetary Policy: Potential Challenges and Risks1

A. Introduction

1. Ensuring an orderly exit from ultra-accommodative monetary conditions is likely to be accompanied by a range of operational and other policy challenges. The Staff Report cites three: containing abrupt, sustained moves in long-term interest rates; managing an effective pass-through from policy tightening to short-term market rates; and coping with potential balance sheet losses.

2. This paper analyzes the first two of these challenges.2 First, the paper discusses potential challenges to raising short-term market rates as the Fed embarks on its tightening cycle. Second, it examines the historical behavior of long-term interest rates and term premia during the last three rounds of monetary tightening in the United States. These episodes suggest that long-term interest rates and term premia may move sharply and unexpectedly during tightening phases, and this can generate uncertainty and complicate calibration of monetary policy. Third, the paper presents a reduced-form empirical model to study the relationship between term premia and macroeconomic and financial fundamentals, as well as a proxy for the Federal Reserve’s unconventional monetary policy measures since late 2008. A series of illustrative simulation exercises quantify the possible responses of term premia to different macroeconomic and financial shocks during the exit process.

3. The chapter’s main conclusions are: (i) relying exclusively on passive run-off will result in a balance sheet that includes larger holdings of MBS than would otherwise be the case; (ii) the transmission of increases in the interest rate on excess reserves to short-term market rates may be less than one-to-one until excess reserve balances normalize; and (iii) term premia may jump abruptly as the Fed begins to wind down its LSAP program, potentially disrupting the transmission channel and endangering a smooth exit. While the Fed has various tools to help manage the exit from its current highly accommodative policy stance, enhanced policy agility, careful calibration of the timing, and effective communication will be key during the exit.

B. Exit Strategy: Operational Challenges

4. At just over $3 trillion, the Fed’s balance sheet is already more than twice as large as it was before the financial crisis (Chart). The composition has also changed. Pre-crisis, the portfolio was comprised almost exclusively of Treasury securities more or less consistent with the maturity distribution of the stock of outstanding marketable Treasury securities and liabilities mostly comprised of costless currency in circulation. Currently, assets include a mix of Treasuries, agency mortgage-backed securities (MBS), as well as agency debt. The overall duration of the portfolio is also longer, partly due to Operation Twist (whereby the Fed sold short-term securities from its portfolio and bought long-term securities), while liabilities are dominated by bank reserves on which the Fed pays interest.


Composition of the Fed’s Assets


Citation: IMF Staff Country Reports 2013, 237; 10.5089/9781484376553.002.A005


Composition of the Fed’s Liabilities


Citation: IMF Staff Country Reports 2013, 237; 10.5089/9781484376553.002.A005

5. The Federal Open Market Committee (FOMC) initially discussed its planned exit strategy at its June 2011 monetary policy meeting. The strategy entails the following steps:

  • First, the Fed plans to cease reinvesting principal payments.

  • At the same time or sometime thereafter, the Fed intends to modify its forward guidance and start draining reserves.

  • Then, the Fed plans to raise the fed funds target and increase the IOER as needed, while continuing to allow securities in its portfolio to mature.

When the Fed first outlined this strategy, the committee had expected to start unwinding its portfolio via outright sales of agency debt and agency MBS sometime thereafter over a 3–5 year period. But since then, the Fed has put less emphasis on asset sales, owing to concerns about market disruptions.3

6. Forward guidance and clear, effective communications are also an important part of the exit strategy. Enhancing its communications has been a long-term objective for the Fed in an effort to bolster its policy effectiveness.4 At its December 2012 meeting the FOMC established a threshold-based forward guidance for the policy rate, though explicitly emphasized that thresholds would not be used mechanically.5 With respect to its asset purchase program, the FOMC indicated in its post-meeting statements that asset purchases will continue until the outlook for the labor market improves substantially in the context of price stability, and that the size, pace and composition of the purchases will take into account the extent of progress toward its economic objectives as well as the likely efficacy and costs of the program. The FOMC also indicated that it is prepared to increase or reduce the pace of purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.

7. Following its June 2013 FOMC meeting, Chairman Bernanke provided additional clarity both in terms of the timing and conditions for scaling back the asset purchase program.6 Specifically, if the economic data remain in line with current expectations, the FOMC expects to moderate the monthly pace of purchase “later this year…[and] continue…in measured steps through the first half of next year,” which is expected to be consistent with an unemployment rate “in the vicinity of 7 percent.” Although the Fed’s forward guidance with respect to the future path of the federal funds rate has not changed, interest rate futures markets appear to have interpreted the clarification of the economic circumstances that might be expected to lead the Committee to scale back the LSAP program as a signal that the policy tightening process is nearing, shifting forward the first hike to mid-2014 or about a year earlier than FOMC participants’ projections suggest.7

8. In principle, it is possible for the Fed to allow its portfolio to shrink exclusively through passive run-off, but it will take a long time for the overall portfolio to normalize both in terms of size and composition. Assuming that QE-related purchases continue through June 2014, it would likely take about five years for the treasury portfolio to revert to its historical norm.8 Based on this simulation, the duration of the portfolio will remain above the historical average for some time.9 The MBS portfolio will take much longer to wind down if the Fed relies only on passive pay-downs, since prepayment speeds will likely slow as interest rates rise. Even under aggressive assumptions for prepayment speeds, the MBS portfolio will likely take roughly 30 years to fully run off.10 An alternative scenario, which assumes that the pace of asset purchases initially slows before the program is fully completed, has only a marginal quantitative impact on the timing for normalization.11 For instance, if the pace of asset purchases diminishes over the period October-December 2013 before the program is discontinued in mid-2014, the treasury portfolio would return to trend growth only a few months earlier than under a scenario that assumes no tapering. A passive normalization of the size of the balance sheet does not necessarily rule out subsequent MBS sales, which could be conducted once the MBS portfolio has been substantially wound down to the point where limited sales would not have a disruptive market impact.12 In the event the Fed opts to conduct outright sales of its existing portfolio holdings, the normalization process would occur more quickly.


Portfolio Normalization Under Passive Run-off


Citation: IMF Staff Country Reports 2013, 237; 10.5089/9781484376553.002.A005

9. While during prior tightening cycles the Fed relied on open market operations to fine-tune monetary policy, the toolkit is much broader this time. First, the Fed has the ability to pay interest on excess reserves. A higher IOER is expected to drive other short rates higher, as banks arbitrage the spread between a lower market rate and a higher IOER, eventually eliminating the difference between the two rates. The Fed also has two reserve-draining tools at its disposal—large-scale reverse repos and a term deposits facility. In the case of the former, the Fed could continuously roll over its reverse repos until the underlying asset matures, effectively resulting in a permanent reserves drain.13 The term deposit facility offers interest-bearing term deposits to depository institutions through a competitive auction process. While an increase in term deposits and reverse repos will have no impact on the overall level of Federal Reserve liabilities, such operations will reduce the aggregate level of reserve balances over the term of the repurchase agreement or term deposit.14 The Fed could also opt to sell assets if there is a need to reduce reserve balances more quickly. While the expansion in the Fed’s toolkit can provide additional levers for reducing accommodation, institutional factors may complicate the coordination of the exit strategy, given different jurisdictions: the FOMC determines the target rate and oversees the large-scale reverse repos, the Federal Reserve Board sets the IOER and oversees the term-deposit facility.

10. The Federal Reserve has faced challenges in controlling the level of the federal funds rate during the crisis. Prior to the financial crisis, the fed funds effective rate traded in tandem with the target rate, as the Fed carefully controlled the supply of reserves using its open market operations. During the initial phase of the crisis, the Fed generally continued to control the supply of reserves carefully, in part by allowing its holdings of Treasury bills to runoff to offset the reserve effect of increased lending, although there were brief intervals in August 2007 when the effective federal funds rate traded below the FOMC’s target. In the fall of 2008, however, the Fed’s direct lending in response to the crisis grew too large to be sterilized by the runoff of securities holdings and the fed funds effective rate deviated from the target rate (Chart). Congress passed legislation in 2008 that authorized the Fed to fast-track its planned introduction interest on reserves. While interest on reserves was helpful as a tool to support the implementation of monetary policy during the crisis, the effective federal funds rate fell and remained below the target and below the IOER rate toward the end of 2008, until the FOMC lowered its target to a range of 0 to 25 basis points in December 2008. The fed funds and the repo markets came under significant stress during the financial crisis, pressuring rates higher and constraining volumes. While repo and fed funds rates traded within a few basis points of each other in the run-up to the crisis, the spreads widened as much as 270 basis points during the crisis, as demand for secured funding rose exponentially (Chart). In contrast to the fed funds market, repo rates and volumes normalized more quickly once the peak of the crisis had passed (Bech, Klee, and Stebunovs, 2012).


Effective Fed Funds and Target Rates


Citation: IMF Staff Country Reports 2013, 237; 10.5089/9781484376553.002.A005


Difference Between Effective Fed Funds Rate and Repo Rate

(Basis points)

Citation: IMF Staff Country Reports 2013, 237; 10.5089/9781484376553.002.A005

11. The effective fed funds rate has remained below the IOER since its inception (Chart). This means that some institutions effectively lend funds at a rate below that paid by the Fed. This is partly because not all participants are eligible to receive interest on their reserve balances. The GSEs, in particular, which are significant lenders of cash in the fed funds market, are not eligible to receive interest on balances held with Fed.15 At the same time, the Fed’s LSAP programs have led to a steady increase in excess reserve balances, in turn reducing interbank trading volumes (since a primary reason for banks to borrow fed funds is to ensure that they maintain sufficient reserves).16


Market and Policy Rates


Citation: IMF Staff Country Reports 2013, 237; 10.5089/9781484376553.002.A005


Effective Fed Funds Rate and Reserve Balances

Citation: IMF Staff Country Reports 2013, 237; 10.5089/9781484376553.002.A005

Prior research (Bech and Klee, 2009) suggests that in an environment of elevated excess reserves, the pass-through from a rise in the IOER to the effective fed funds rates may be less than 1 to 1. To keep the effective fed funds rate near the FOMC’s target rate, the Fed may need to drain a large volume of reserve balances (Chart). Since the Fed originally laid out is exit strategy in June 2011, the balance sheet has grown even larger, with the securities portfolio expanding by an additional $500 billion (18 percent), which further increases the challenge for managing draining operations and exerting control over short-term rates.

12. But the Fed has a few options to strengthen the pass-through from a rise in IOER to the fed funds rate. First, the Fed could raise the IOER, possibly to a level above the FOMC’s target rate, to try to keep short-term market interest rates close to the FOMC’s target rate. Second, the Fed could step up its reserve-draining operations, though there may be constraints on the capacity or willingness of the counterparties, especially if the money market funds continue to shrink or if broker-dealer balance sheets remain constrained.17 Third, if the stickiness is only apparent in the fed funds effective market and if other short-term rates remain close to the FOMC’s target rate, the Fed could focus on guiding other short-term money market rates as the dominant policy variable. To reduce downward pressure on the fed funds market, another (albeit unlikely) alternative is to enact legislation that would enable the GSEs to earn interest on their reserves and/or lead the GSEs to downsize their balance sheets and or somehow reduce their dominance in the fed funds market.

C. Exit Strategy and Long-Term Bond Yields

13. Long-term bond yields behaved differently during recent episodes of monetary tightening, largely due to different responses in the term premium (Chart). The 1994-1995 tightening episode—which saw policy rates rise 300 bps over a 13-month period—was accompanied by a substantial increase in the term premium, reflecting concerns among bond investors over inflation and a lack of policy transparency from the Fed, which in turn caused undesirable market volatility and reinforced the increase.18 During the 1999–2000 episode, when policy rates rose by a more modest 175 bps over a similar timeframe as in 1994–5, there was a more subdued rise in the term premium. In contrast, the 2004–06 cycle, which saw policy rates rise by 425 bps in 25 bps increments over a two-year period, was accompanied by a substantial decline in the term premium, arguably leading to a somewhat more accommodative policy stance than intended by the Fed.19


Drivers of Ten-Year Treasury Yield During the First Year of Tightening

(Percentage Points)

Citation: IMF Staff Country Reports 2013, 237; 10.5089/9781484376553.002.A005

15. A rapid change in the term premium might complicate the exit from QE and normalization of monetary policy. Various factors could potentially exert sudden upward pressure on the term premium in the forthcoming cycle, including, for instance, uncertainty about the U.S. or global economic recovery and inflation outlook or general policy uncertainty as the Fed seeks to re-normalize monetary policy conditions. If protracted, such pressures could weigh on the recovery and have negative international spillovers.

16. To assess this risk, we rely on an econometric model of the term premium. In particular, we explore the statistical relationship between the ten-year term premium (estimated using the model described in Kim-Wright, 2010) and a set of variables closely associated with its movement (described in Table 1), including changes in macroeconomic fundamentals, macro uncertainty, financial market volatility, and changes in the Fed’s LSAP program. The methodology follows Gagnon, Raskin, Remache, and Sack (2010) and Wu (2011).

Table 1.

Variable Included in Ten-Year Term Premium Model

article image

17. To investigate the effect of QE on long-term bond yields and term premia, we construct a measure of market’s expectations of the size and persistence of the LSAP program. Using the methodology of Chung, Laforte, Reifschneider, and Williams (2012), we calculate the present discounted value of the current and expected future SOMA (System Open Market Account) balance in excess of its historical normal level, expressed as a ratio to potential GDP, after each major policy announcement from the FOMC since late 2008 (Chart). Market expectations of the future path of SOMA holdings are formulated based on the evolution of the LSAP program since late 2008 as announced by the FOMC, as well as the Fed’s exit principles, as outlined in the June 2011 FOMC meeting minutes and subsequently clarified following the June 2013 FOMC meeting. The chart displays the evolution of the projected excess SOMA holdings over time. The red line tracks real-time market expectations of future excess SOMA holdings, the present discount value of which is our measure of the magnitude of QE. This measure also reflects the influence of the FOMC’s forward guidance on the market’s expectations of the Fed’s portfolio holdings. For instance, on January 25, 2012, the FOMC extended its guidance on the low interest rate from “at least through mid-2013” to “at least through late 2014.” Even though there were no explicit changes to the LSAP program on the day, the projected path of SOMA balance moved upward (the green dotted line in the chart), as the delay in the first rate hike by more than a year led markets to speculate on a similar delay in the LSAP unwinding schedule. There was a moderate change in this measure following the June 2013 FOMC meeting.

18. The model estimation suggests that term premia are closely related to macroeconomic fundamentals, in particular labor market conditions, financial market volatility, and unconventional monetary policy measures as well as uncertainty on future policy actions. Detailed coefficient estimates are reported in Table 2. Term premia are countercyclical, increasing when the unemployment rate, financial market volatility, or monetary policy uncertainty rise. An expansion in the Fed’s holdings effectively lowers the term premium.

Table 2.

Determination of Ten-Year Treasury Term Premium

article image
Source: IMF staff estimates. ***, **, and * denote 1, 5, and 10 percent significance level, respectively.

19. Estimation results suggest that QE has lowered the ten-year term premium by over 100 basis points since September 2008. More than half of the 210 bps decline in the ten-year Treasury bond yield between September 2008 and March 2013 can be attributed to the decline in term premium. A decomposition of the changes in the term premium provides some insight into the driving forces behind its observed decline (Table 3). In particular:

  • Changes in macroeconomic fundamentals during this period increased the ten-year term premium by 30 basis points, largely due to an increase in the unemployment rate;

  • Declines in macroeconomic volatility had a negligible effect on the term premium, amounting to only 10 basis points;

  • Reduced financial market volatility and near-term short-rate uncertainty since late 2008 helped lower the term premium substantially, by more than 70 basis points;

  • Changes in market expectations of the Fed’s balance sheet size caused by the various LSAP programs and forward guidance announcements lowered the ten-year term premium by about 100 basis points.

Table 3.

Decomposition of Changes in Ten-Year Term Premium: September 2008 to March 2013

article image
Source: IMF staff estimates.

20. Building on the model it is possible to construct a series of simulations on the movement in the term premium prior to and during the exit. In particular, three scenarios are constructed over the next few years starting in the second half of 2013:

  • Baseline: this scenario is consistent with the assumptions laid out in the staff report, projecting a gradual and steady economic recovery; macroeconomic fundamentals and financial market volatility will gradually revert to their historical (pre-crisis) average in the first quarter of 2016; purchases of long-term Treasury bonds and agency MBS are projected to continue at the current pace through late-2013 and then are gradually scaled back over the course of 2014; the first federal funds rate increase is expected to occur in early 2016.

  • “Rush to Exit”: this scenario involves increased sensitivity among bond investors to the unwinding of LSAP assets, combined with a misperception of the Fed’s LSAP unwinding schedule. In particular, it assumes that market participants mistakenly assume that the LSAP unwinding will occur two quarters sooner than in the baseline scenario, and will be completed in three instead of five years. The elasticity of the term premium to changes in the present discounted value of the SOMA balance sheet also rises by two standard deviations, to capture the associated changes in market sentiment.20

  • “Rush to Exit” in the midst of heightened policy uncertainty and financial market volatility. Under this scenario, a misperception of the Fed’s forward guidance and QE policy lead the market to believe that the LSAP unwinding may occur two quarters earlier and will be finished in three instead of five years. In addition, elevated policy uncertainty generates higher volatility in stock and bond markets, amounting to a two-standard-deviation shock to each variable, lasting one quarter, respectively.21 Moreover, the response of the term premium to the LSAP unwinding also becomes stronger, as the elasticity rises by two standard deviations, as in the “Rush to Exit” scenario above.

21. The term premium reacts differently under each scenario (chart). Under the baseline scenario, the ten-year term premium gradually rises from the current level of -48 basis points to positive territory in early 2016, and back to its pre-crisis level of around 50 basis points by 2020. However, if market participants suddenly become overly sensitive and begin to speculate that the LSAP unwinding will begin in the second half of 2013 (“Rush to Exit” scenario), the term premium jumps immediately by about 60 basis points, despite the fact that the actual exit will not occur for at least two more years.


Simulated Shocks to Ten-Year Term Premium

(Percentage points)

Citation: IMF Staff Country Reports 2013, 237; 10.5089/9781484376553.002.A005

22. The initial increase in the long-term bond yield is even greater in the presence of more general uncertainty over the monetary policy stance and elevated financial market volatility. Events that lead the market to expect an earlier unwind of the LSAP may also trigger a change in the expected timing of short-term rate increases, thereby driving 10-year bond yields higher. A simple calculation suggests that expectations of an earlier federal funds rate “lift-off” of two quarters may increase the ten-year bond yield by at least 25 basis points. Changes in market sentiment may also be accompanied and further reinforced by heightened financial market volatility. In our third scenario (“Rush to Exit” in the midst of heightened policy uncertainty and market volatility), higher financial market volatility leads to an additional 40 basis point increase in the ten-year term premium, resulting in an overall jump in the term premium of almost 100 basis points and an increase of more than 125 basis points in ten-year Treasury bond yields. The magnitude and persistence of such increases would be comparable to those of Greenspan’s “long-term bond yield conundrum” during 2004–2006—but in reverse—and would likely generate pervasive effects on the U.S. economy and global financial markets.

23. Enhanced policy communications with the public are vitally important prior to and during the exit. Improved transparency will be able to effectively reduce the associated policy uncertainty and misperceptions about both the forward guidance on short-term interest rates and the LSAP unwinding schedule, which directly target the expectations component and term premium component of long-term bond yields. Moreover, it will also help ease market jitters and guide the public through the “unchartered waters”, given their unfamiliarity of the policy environment.

24. The flexibility to adjust the LSAP unwinding schedule is another important policy tool to accommodate a more persistent shock to term premium and long-term interest rates. If the market suddenly learns that the LSAP unwinding will be postponed by another four quarters, the ten-year term premium will immediately decline by more than 15 basis points, and the declines will be quite persistent (Chart). This is already more than enough to offset the two standard deviation shock to bond-and stock-market volatilities as simulated above. Moreover, if such a delay is accompanied by an increase in the current pace of asset purchases to the tune of $500 billion in additional purchases through the first half of 2014, the term premium will decline by another 14 basis points.


Term Premium Responses to Extensions of LSAP Program

Citation: IMF Staff Country Reports 2013, 237; 10.5089/9781484376553.002.A005

25. In sum, designing and executing a smooth withdrawal of the monetary policy stimulus over the next few years may present challenges. While the Fed has a range of tools to help manage the exit from its current highly accommodative policy stance, the Fed may face challenges associated with the responsiveness of market rates as monetary policy accommodation is unwound. Heightened uncertainty in macroeconomic fundamental and financial market conditions, market sentiment over the LSAP unwinding timing and magnitude, a lack of familiarity of the new policy environment, may further complicate the implementation of monetary policy. Improved public communications and transparency, as well as enhanced policy agility and flexibility, will be critical in guiding a smooth transition during the exit process.

Figure 1.
Figure 1.

Shifts in Projected Path of Excess SOMA Holding

(Percent of potential GDP)

Citation: IMF Staff Country Reports 2013, 237; 10.5089/9781484376553.002.A005


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Prepared by Rebecca McCaughrin (MCM) and Tao Wu (ICD).


On the third challenge, see Box 2 in IMF (2013), which estimates potential losses on a net present value basis under different macro scenarios, ranging from 1 to 4.5 percent of GDP.


Chairman Bernanke indicated in his Congressional testimony to the Joint Economic Committee (May 22, 2013) and in his comments during the June 2013 FOMC meeting press conference that the Committee does not anticipate selling MBS from the Fed’s portfolio, except perhaps to reduce or eliminate residual holdings.


See speech by Janet Yellen, “Communication in Monetary Policy,” April 4, 2013.


The Fed committed to keep the federal funds rate close to zero at least as long as the unemployment rate remains above 6½ percent, inflation projected 1–2 years ahead is not above 2½ percent, and longer-term inflation expectations remain well-anchored. The Fed’s forecasts suggest that macroeconomic indicators are consistent with keeping the federal funds rate exceptionally low at least through mid-2015.


See FOMC: Press Conference on June 19, 2013.


Some of the repricing may also reflect an increase in term premia as well as increased margin requirements on Eurodollar interest rate futures by the Chicago Mercantile Exchange.


The historical norm is defined as a growth rate consistent with growth in estimated currency in circulation.


The Fed has already allowed to run-off or sold all treasuries under 3-year tenors, so it will take a few years before passive run-off starts to reduce Treasury holdings significantly.


Mortgage conditional prepayment rates of 15–20 percent are assumed in the near-term before returning to 10 percent in the longer run, based on Bank of America Merrill Lynch’s prepayment model estimates.


Assumptions on the pace of tapering are based on median market expectations.


During his press conference remarks following the June 2013 FOMC meeting, Chairman Bernanke noted that “in the longer run, limited sales could be used to reduce or eliminate residual MBS holdings.”


The Fed has also expanded its counterparties for reverse repo operations beyond its usual set of primary dealers to include banks, money market mutual funds, and the GSEs.


The Fed has already conducted reserve-draining operations to test out the functionality of these tools on a limited basis, and will likely step up its test transactions as the exit period nears.


The FDIC asset-based fee levied on depository institutions has reduced the incentive for banks to arbitrage away the difference. At around 10 bps, this fee lowers the returns gained from borrowing in the fed funds market from the GSEs and then depositing the funds at the Fed. Some banks that are exempt from the FDIC fee (e.g., foreign-owned branches and other banks with small deposit bases) have sought to arbitrage the difference, but not enough to diminish the spread.


Fed funds effective trading volumes were around $250 billion pre-crisis and have fallen to approximately $50 billion per day currently. Repo (GC treasury, tri-party) volumes have fallen as well, but by much less: pre-crisis volumes were around $450 billion per day versus $350 billion currently. See Bech and Klee (2009).


If reverse repos occur in large size, there is the potential to cause repo rates to rise notably relative to other money market rates, which could have adverse effects on other large repo borrowers. Such spillover effects could increase the cost of reserve-draining via a large-scale reverse repo program.


The substantial variations and possible non-linearity in the bond market’s response to the Fed’s unconventional monetary policy measures suggest that changes of such a magnitude are plausible. For reference, the estimated elasticity in Table 2 implies a total effect of -35 basis point of QE I on the ten-year term premium, while the literature has provided a wide range of estimated effects of QE I, from 30 basis points to 100 basis points. Increasing the elasticity by two standard deviations raises the magnitude of the estimated effect from -35 to -51 basis points, almost identical to the -50 basis points as assumed by Chung, Laforte, Reifschneider, and Williams (2012).


The sizes of such volatility increases are slightly smaller than those as observed in the first two quarters of the 1994–1995 tightening; therefore shocks of such sizes are quite possible.

United States: Selected Issues
Author: International Monetary Fund. Western Hemisphere Dept.