John Taylor says that the Fed could sell its MBS without having a material impact on interest rates

His blog post is here. I will download the paper when I get into the office tomorrow ( I can only download NBER papers while on campus).

But one thing from the blog post strikes me as strange: he uses spreads on agency debt as his measure of credit risk. But the very fact that the Fed has purchased MBS could produce a perception that the government is standing behind the debt--as the Fed exits, so too might this perception. I would also imagine that the low current interest rates mean expectations about prepayment are unusual at the moment, and that the most common methods for pricing the mortgage call option might not be appropriate either.

The point is that it is very difficult to separate total mortgage interest rates into the term-adjusted risk-free interest rate, the credit spread and the prepayment spread. More after I actually read the paper.

[update: I just read the paper. Taylor describes it well in his blog post, which means that I have not seen anything to change my mind that it is not very convincing. More to come soon].