Exchanging Nickels for Dimes?
By Arnold Kling
Suppose that the Federal Reserve were to sell off all its Treasury securities of less than one-year maturity, and use the proceeds to buy up all the longer term Treasury debt it could. For example, in December of 2006, this would have required selling off about $400 B in bills and notes or bonds with less than one year remaining, with which the Fed could have effectively retired all Treasury debt beyond 10 years….Yields on maturities longer than 2-1/2 years would fall, with those at the long end decreasing by up to 17 basis points. Yields on the shortest maturities would increase by almost as much.
I have not read the paper, but I have some methodological observations.
1. He really touts the statistical significance of the results, even though he acknowledges that the economic significance is pretty small.
2. It seems to me that the exercise he talks about, consisting of a $400 billion exchange of assets by the Fed, is probably well outside the normal historical range. I don’t know about the techniques used here, but usually when you extrapolate an effect that has been observed within one range to something completely outside the range it is pretty unreliable.
In any case, this paper reminds me ofthis installment of the Macro Doubtbook, in which I discussed
the relationship between finance theory and macroeconomics. I think that relationship is an uneasy one.
“Portfolio balance theory” is contradicted by much theoretical and empirical work in finance. That is why Hamilton is excited that he and co-author Cynthia Wu have found any statistically significant results at all. But still, the results seem small to me. They are closer to what you would get if you thought of the Fed exchanging nickels for dimes than if you think of it as some all-powerful manipulator of interest rates.