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Why an MBS-Treasury Swap is Better Policy than the Treasury Twist,” unpublished, Kellogg School of Management

By Arvind Krishnamurthy and Annette Vissing-jorgensen

Abstract

This note compares the effect of an MBS-Treasury swap (a strategy of purchasing long-maturity agency MBS and selling long-maturity Treasury bonds) versus the Treasury twist (purchasing long-maturity Treasury bonds and selling short-maturity ones). We make two main points: 1. Purchasing long MBS brings down long MBS yields by more than would an equal sized purchase of long Treasury bonds and thus is likely to create a larger stimulus to economic activity via a larger reduction in homeowner borrowing costs 2. Purchasing Treasury bonds brings down Treasury yields, but this decrease indicates a welfare cost rather than a benefit to the economy. Thus it would be better to sell rather than purchase long-term Treasury bonds. These points lead us to conclude that a superior large-scale asset purchase policy for the Fed is an MBS-Treasury swap where the Fed purchases long-maturity MBS, financed by a sale of longmaturity Treasury bonds. MBS rates fall more when the Fed purchases MBS than when it purchases Treasurie

Year: 2012
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