Despite the recent dip in the size of the balance sheet, the size of the purchase programs underway makes it likely that balance-sheet growth will resume as assets acquired in conjunction with these programs overwhelm any further declines in the funds advanced via the shorter-term liquidity facilities. The size of the Federal Reserve’s balance sheet seems likely to grow to roughly $2.5 trillion, somewhat above the peak reached last December.

[W]hile one can argue that by agreeing to purchase up to $300 billion in long-term U.S. Treasuries, the FOMC provided a needed short-term tonic to private credit markets, we dare not come to be viewed as a handmaiden to the Treasury. By loosening the anchor we have established for long-term inflation expectations, we could create the perception that monetary policy is subject to political imperatives, doing lasting damage to our ability to maintain price stability and restore full employment. I believe we have come as close as we dare to the line between acceptable and unacceptable risk in this regard, and do not personally wish for us to expand or extend our purchases of Treasuries beyond the cumulative $300 billion planned by this fall.

The program {asset purchases} appears to be having its intended effect. Yields on mortgages relative to Treasury yields have come down since November 2008...[T]he 30-year fixed mortgage rate relative to the 5-year constant maturity Treasury rate benchmark has declined about 1-1/4 percentage points since the first MBS purchase program was announced. Indeed, today mortgage spreads are a lot closer to their mean for 2000-2007 than they were in November. That said, mortgage rates have recently risen with the increase in Treasury rates.

The main danger of a Treasury purchase program is that people may wrongfully conclude that there is a risk that you are going to monetize the debt and reinflate.

The Federal Reserve will not monetize the debt, and I think it's important to point out that notwithstanding our purchases of Treasuries as part of a program to strengthen private credit markets, even when we complete the $300 billion purchase that we have committed to, we will still hold less Treasuries, a smaller volume of Treasuries, than we had before the crisis began.

I think it pays to keep your options open. Conditions have clearly improved, and that’s gratifying, and so I think those numbers look reasonable to me at the moment, but the last 21 months have been very challenging months, to put it mildly… So I think we need to keep an open mind.

In response to a question about what would make him favor increasing the scale for Treasury purchases above the initial $300 billion target.

[W]hen the FOMC announced in March that the Fed would expand these purchases, interest rates declined on both Treasury securities and agency-backed MBS. Still, even though these programs appear to be having a useful effect, we have little experience with them and the magnitude of their impact is uncertain. In other words, it is difficult to tell if unconventional monetary policies will be as effective in promoting recovery as easing the funds rate has been in the past.

[T]he Federal Reserve and other central banks regularly buy and sell government debt in open market operations, and we've been doing that for many years. We purchased -- we announced a plan to purchase $300 billion in order to try to provide broader liquidity and try to help private credit markets. That's our objective.

And we think it's been beneficial, because we've seen improvements in mortgage markets and corporate bond markets and so on.  We're not trying to target a particular interest rate. Again, our objective is to provide more liquidity to the system and to help private credit markets, and I think that it has had some benefit.

...

Well, again, our objectives have nothing to do with the government's debt, per se. Our objectives have to do with strengthening private credit markets, and those decisions will have to be made by the FOMC as we look at the state of the economy and try to judge the efficacy of the very steps that we've taken.

In response to questions about the Fed's goals in purchasing long-term securities

"They're {Fed securities purchase programs} sized about right...given how I'm expecting the recession to play out over the course of the year," Lacker said following a speech.  "If things turned out differently, I could change my mind about the appropriate scale and trajectory of those programs," he said.

As best we can tell, so far the {GSE and Treasury securities purchase} programs are having the intended effect. For example, 30-year fixed mortgage rates, which responded very little to our cuts in the target for the federal funds rate, have declined 1 percentage point to 1-1/2 percentage points since our first MBS purchase program was announced in November. Over time, lower mortgage rates should help to improve conditions in the housing market, whose persistent weakness has had a major impact on economic and financial conditions more broadly, and will improve the financial condition of some households by facilitating refinancing. In addition, open-market purchases should benefit credit markets by adding liquidity and balance sheet capacity to the system.

In addition, the FOMC took the very significant step of launching a new program to purchase large quantities of longer-term Treasury debt. Purchases of such longer-term assets have the potential to stimulate aggregate demand through a number of channels, most obviously by reducing the yields on those securities included in the program. Indeed, last week’s announcement resulted in an immediate and sharp decline in interest rates on both Treasury securities and agency-backed MBS. Similar effects on interest rates were felt in the United Kingdom after the Bank of England announced a program to buy long-term government debt there.

'Judging from the Fed's action, at this point in time the Fed has judged buying long-term Treasuries is not the most efficient means of easing financial market conditions,' Dudley said in response to audience questions after giving a speech.

As reported by Reuters

Well, I think you have to solve the problem you've got.  And the problem we've got is not a lack of liquidity or a lack of purchases of Treasuries.  The problem we've got is that so many of our critical credit markets are not functioning properly. The securitization market's not functioning, the mortgage market. If we want to help the economy grow again, we got to get those markets working.

The programs we've done are not credit allocation, because they're very broad-based. The TALF is addressing a wide range of assets and we're leaving to the private sector the decision to which assets to bring to the TALF.  The mortgage market is a very broad-based market, and it affects the whole economy. So I -- I think, and -- and as far as getting out of it is concerned, I already discussed earlier the unwinding process. I think we'll be able to do that.

So I think you have to solve the problem you've got, not the problem you haven't got.

In response to a question about why Bernanke had voted not to buy Treasuries and pursue a quantitative easing at the January FOMC meeting.

Bernanke: "Our objective is to improve the functioning of private credit markets so that people can borrow for all kinds of purposes. We are prepared and we want to keep the option open to buy Treasury securities if we think that is the best way to improve the functioning or reduce interest rates in private markets."

"So we are certainly going to keep that option open. I should say though, that we do have a couple of other things going on right now, one is the purchases of the agency MBS and securities, the other is the proposed expansion of the TALF. So those are two directions that are certainly going to be taking up a lot of our attention in the short run. So, we will keep that option open but we are looking at some other ways of addressing private markets as well."

Q: Will an "unacceptable" rise in long-term Treasury rates and slow economic growth will result in the Fed buying longer-term Treasury securities?

Bernanke: "Well we want to look at the overall state of the economy. One possible scenario would be the Japanese scenario where there was a more general quantitative easing type approach, where the focus was not specific credit markets but braodening the monetary base in general. In that case the Japanese have, and currently are, buying long-term government bonds, that would be one possible scenario.

"But again, the basic goal here is to improve the functioning of private credit markets, we are not trying to affect the cost of government finance per se, rather the private sector.

From the Q&A session, as reported by Market News International

The Federal Reserve must, of course, be very careful to avoid any perception that it stands ready to monetize exploding fiscal deficits, as this would undermine confidence in our independence and raise serious doubts about our commitment to long-term price stability. These concerns certainly do not preclude some Treasuries purchases, however, as we seek to strengthen the economy in this time of crisis. With short-term Treasury rates near zero, an argument can be made that buying longer-term Treasuries would be especially effective in this regard.

Parenthetically, I would note that such purchases are not at all unusual. We routinely buy Treasury issues with a wide range of maturities in order to maintain a well-balanced portfolio. So, we are talking only about a possible change in emphasis here, not a sharp departure from past practice. That said, in my opinion, we certainly shouldn't try to peg long-term rates. Past efforts to do so soon have led to costly credit-market distortions and inevitably ended in tears. In my view, we must be very careful not to provide for an unsustainable and potentially disruptive distortion in the benchmark market for Treasuries through any extraordinary efforts above and beyond our normal balancing operations.

Similarly, we must be very cautious about the dimensions of our program to intervene directly in the market for asset-backed securities, making sure that our actions are the absolute minimum needed, and no more. Most important of all, we must continue to make clear that we will unwind our interventions in the market and shrink our balance sheet back to normal proportions once our task is accomplished, for this is, indeed, our unanimous and unflinching intention.