Yield-curve control
The Economist Jan 30th 2020
A yield curve: background
• A yield curveis a line drawn through the effective interest rates on government securities with different maturities.
• In normal times, this line slopes upward: long-term rates are higher than short-term ones, to compensate for the higher risks—mainly inflation—of investing for a longer period.
Prepare for future downturns (Jan 2020)
• Many hazards complicate the job of Jerome Powell, the chairman of the Federal Reserve, from meddling presidents to pandemics.
• At the press conference following the Fed’s
monetary-policy meeting on January 29th, he was grilled on its likely response to all of these.
• But Mr Powell’s biggest problem is a more enduring and global one: interest rates are stubbornly low.
“Unconventional” tools
• The Fed’s main policy rate will almost certainly be cut to zero, forcing it to rely once more on its
“unconventional” tools.
• Mr Powell has said he is open to considering
yield-curve control, a new approach borrowed from Japan.
Overnight interest rates would rise
• During the global financial crisis the hope was that when recovery arrived overnight interest
rates—central banks’ preferred policy lever—would rise, restoring business as usual
• In fact, despite a resilient global expansion, few rich-world countries have left zero behind.
• In a recent lecture Ben Bernanke, a former Fed
chairman, argued that the unconventional tools used during and after the crisis worked reliably and
QE (quantitative easing)
• Before the crisis, the Fed traded bonds to keep overnight interest rates within a desired range.
• With QE by contrast, bond purchases are an end in themselves.
• Rather than announce changes to rates, central
bankers inform markets of the quantity of bonds they will buy (hence “quantitative”) with newly created money.
Effects of QE
• When investors sell long-term government bonds to the central bank, the thinking goes, they use the cash they receive to buy other assets, such as corporate bonds or equities.
• Higher stock and bond prices in turn encourage firms to invest, boosting the economy.
• Some evidence suggests that QE is subject to diminishing returns.
Yield-curve control
• Yield-curve control would allow a central bank that has cut its overnight rate to zero to set rates for bonds of longer maturities.
• The Bank of Japan began its programme by targeting a yield of 0% for ten-year Japanese government bonds.
• An American version might begin by capping the rate for one-year bonds, then adding in longer durations as needed.
Keep yields on target
• No announcements regarding the buying or selling of bonds would be necessary; the Fed would simply transact in the bond market to keep yields on target, as it does for overnight rates.
