Lastly, when participating in non-sovereign markets for the first time, a central bank might need to learn more about the asset class and build or refine the internal systems needed to operate in that market.11 In all these cases, a central bank might choose to diversify across different asset classes to achieve its policy objective. With these considerations in mind, I now want to turn to a discussion of the large-scale asset purchase programs pursued by the Federal Reserve. My focus will be on the Fed’s agency MBS purchases—which provide the central bank with an additional policy transmission tool and significant additional capacity to provide policy accommodation. Although the purchase of U.S. Treasuries is not central to my remarks, it is important to note that the Federal Reserve is fortunate in having a sovereign debt market that is the deepest and most liquid in the world and is sufficiently large that there are no close capacity limits. The experience with the three LSAP programs and the Maturity Extension Program showed that the Federal Reserve was able to purchase Treasuries at a fast pace without affecting market functioning. Before continuing to the main part of my discussion, I would also note that my intention is to consider the practical and operational issues surrounding the implementation of LSAPs, rather than to debate the merits of LSAPs relative to other potential monetary policy tools. There are a number of important issues linked to the potential costs of LSAPs but unrelated to these implementation issues.
While this might appear to be a constraint for the Federal Reserve, purchases of non-sovereign debt by other central banks have been small—both in size and as a percentage of GDP— compared with the Federal Reserve’s purchases of agency MBS, which are guaranteed by federal agencies and can affect private borrowing rates.8 In expanding their balance sheets through asset purchases, central banks must consider how their choice of assets—for example, sovereign debt, corporate bonds, or federal agency debt— will affect the policy transmission mechanism. Central banks must also take into account any implementation challenges related to executing in a given market. There are many broad transmission channels through which an LSAP program can provide additional monetary accommodation: Increasing the monetary base and central bank liabilities—the QE channel Reinforcing that interest rates will remain low—the signaling channel9 Changing the quantity and mix of financial assets held by the private sector—the portfolio balance channel Taking interest rate risk out of the private sector—the duration channel Taking credit risk out of the private sector—the credit channel Taking prepayment risk out of the private sector—the prepayment channel Improving market function—the market function channel The purchases of different assets will have different degrees of impact across these channels. For example, sovereign assets will generally work primarily through the first four channels, while corporate bonds would also work through the credit channel and MBS would also work through the prepayment channel.