1 Transferring this additional duration risk to the Federal Reserve’s portfolio, and hence out of the portfolios of market participants, was one channel through which the asset purchase program was intended to have its effect on financial conditions. This “portfolio balance” channel has been discussed by Chairman Bernanke on several occasions. 2 This view associates the amount of policy stimulus with the stock of assets, or more precisely with the amount of duration risk, that the Federal Reserve takes onto its balance sheet. Policy achievements of LSAP2 The purpose of the asset purchase program was to help the Federal Reserve achieve the economic objectives of full employment and stable prices that it was given by Congress. I believe that the program delivered what could have been expected from it. In particular, let me highlight its success along two dimensions. First, the LSAP2 program made broad financial conditions more accommodative. This conclusion can be drawn from the behavior of financial markets from late August 2010 to the program’s implementation date in November 2010 – a period during which market participants moved from seeing such a program as a remote possibility to expecting it with near certainty. 3 Asset price movements over this period included a decline in real interest rates, a narrowing of risks spreads, an increase in equity prices, and a decline in the dollar – exactly the pattern that one would expect to be generated from additional monetary policy accommodation.
These changes likely supported economic growth and the creation of employment relative to what would have been realized in the absence of the program. 4 Second, the LSAP2 program appears to have raised inflation expectations from unusually low levels and reduced the threat of deflation. The downside risks to inflation had become quite threatening by last summer. Breakeven inflation rates had moved to levels that were well below those consistent with the FOMC’s mandate, even for forward measures covering periods beginning several years ahead. In addition, the pricing of deflation risk, as computed by looking at Treasury inflation-protected securities with different amounts of accrued inflation, reflecting fairly substantial odds of deflation over the next several years. 5 Since that  1  Estimates of the contribution of additional risk coming from the increased size of the portfolio range from 60 percent to 80 percent, while estimates of the impact of its longer duration range from 20 percent to 40 percent. 2  See, for example, Chairman Ben S. Bernanke (2010), “The Economic Outlook and Monetary Policy”, remarks at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, August 27. 3  One would expect market prices to incorporate nearly all of the effects of the programs in advance rather than during the actual implementation of the program. Thus, the period before the November implementation is the most relevant period for assessing the program’s effects.