Does Quantitative Easing Affect Market Liquidity?

Abstract

We argue that central bank large-scale asset purchases—commonly known as quantitative easing (QE)—can reduce priced frictions to trading through a liquidity channel that operates by temporarily increasing the bargaining power of sellers in the market for the targeted securities. For evidence we analyze how the Federal Reserve’s second QE program that included purchases of Treasury inflation-protected securities (TIPS) affected a measure of liquidity premiums in TIPS yields and inflation swap rates. We find that, for the duration of the program, the liquidity premium measure averaged about 10 basis points lower than expected. This suggests that QE can improve market liquidity.