Abstract

This paper investigates the effect of purchases of U.S. Treasury bonds by foreigners on long-term yields and the term-premium. I set up a consumption-based model with habit preferences, calibrate it to match data on U.S. Treasury yields, and find that each additional 100USD billions of foreign official purchases of U.S. Treasuries decreased long-term yields by 50 basis points prior to the financial crisis 2008-2009. Half of this change is explained by a drop in the term-premium: Foreign purchases increased domestic agents’ consumption above their past consumption, reducing their risk-aversion and decreasing the term-premium. Finally, I show that a reversal of foreign inflows results in a sharp increase in long-term yields.