How Quantitative Easing Actually Works

Researchers face formidable challenges in measuring these effects, however. Selgrad created a model that captures unexpected Fed purchases of individual Treasurys during each of its QE operations. Then she used data on investors’ holdings to examine how they rebalanced their portfolios in response to the Fed’s actions and the resulting effect on yields.

Selgrad focused her analysis on $5.3 trillion of Treasury coupon purchases involving more than 1,000 operations between November 2010 and December 2021. During that time period and since then, the Fed has released a tentative schedule of its QE operations in advance, providing a guide to the total amount it will purchase in each operation, as well as which broad maturities it will purchase from. In information released on its website, the Fed states that it prefers purchasing Treasurys that are relatively cheap and does not concentrate purchases in individual Treasurys to avoid impacting liquidity.

While the Fed has not announced beforehand how much of each individual Treasury it will purchase, it is possible to construct a prediction of this given the publicly available information, which is what the paper does. Subtracting the predicted amount from the actual amount purchased leaves the amount purchased that the market did not expect.

The Booth-affiliated Center for Research in Security Prices supplied detailed data on Treasurys, and Selgrad obtained information on corporate bonds from the Trade Reporting and Compliance Engine. Morningstar provided data on US-based mutual fund holdings. Data on company-level capital expenditures, research and development, and other measures came from Compustat.

Combining the data on holdings with the QE shocks that her model identified, Selgrad analyzed how funds rebalance in response to QE. When the Fed bought Treasurys, funds sold them and rebalanced more than 60 percent of the proceeds into corporate bonds—both those of similar maturities to the Treasurys bought by the Fed, and those of companies whose debt they already owned.

This rebalancing caused yields on those securities to fall. For each $100 billion in Treasurys the Fed purchased, corporate bond yields declined by about 8 basis points at the time of the transaction, the research demonstrates. This in turn enabled companies to increase bond issuances while offering buyers lower yields. They used the proceeds to increase capital investments and cash buffers, according to the study.

These findings of a significant decline in bond yields clearly indicate the powerful effect that QE has on portfolio rebalancing and on supporting the economy.