What Is Yield Curve Control (YCC)?
Yield curve control (YCC) involves targeting a longer-term interest rate by a central bank, then buying or selling as many bonds as necessary to hit that rate target. This approach is dramatically different from the Federal Reserve's typical way of managing U.S. economic growth and inflation, which is by setting a key short-term interest rate, the federal funds rate.
Key Takeaways
- Yield Curve Control (YCC) by the Fed would target specific long-term rates levels.
- It sharply differs from quantitative easing (QE) in its approach.
- YCC may be needed for economic stimulus as short-term rates near zero.
- Former Fed chairs Bernanke and Yellen support the use of YCC.
- Various countries such as Japan and Australia have enacted yield curve control strategies to varying degrees of success.
Understanding Yield Curve Control (YCC)
Yield curve control is a monetary policy tool used by central banks to manage interest rates across different maturities of government bonds. It involves targeting specific yields or interest rates on government bonds with different maturities, typically aiming to keep long-term interest rates at a desired level.
Traditionally, central banks focused on setting short-term interest rates, but when short-term rates approach zero and there is limited room for further cuts, they may turn to yield curve control as an additional tool. Yield curve control primarily aims to provide more certainty and stability to long-term interest rates, stimulating borrowing and investment, supporting economic growth, and encouraging inflation. It can also be used to cool down economic activity and prevent excessive inflation.
Yield curve control has been employed by central banks in various countries, including Japan, Australia, and the United States. The specific implementation and details of YCC can vary depending on the central bank's policy framework and objectives. The specific implementation and impact of YCC can vary depending on the country, central bank, and economic circ*mstances.
Yield Curve Control vs. Quantitative Easing
Through quantitative easing (QE) designed to combat the 2008 financial crisis and Great Recession, the Fed injected liquidity into the financial system through massive purchases of bonds on the open market. This bid up the prices of bonds, thus reducing longer-term interest rates and borrowing costs.
However, during the financial crisis, the Fed was not seeking to set a specific long-term interest rate. By contrast, under yield curve control, the Fed would set a specific long-term interest rate target and buy as many bonds as necessary to achieve it. YCC would set a specific price for the bonds in terms of their yield.
In this context, both YCC and QE are monetary policy tools used by central banks. However, QE is more open-ended and aims to influence overall financial conditions, while YCC targets specific yields on government bonds to stabilize long-term interest rates. YCC aims to influence borrowing costs and investment decisions, while QE focuses on overall financial conditions and the money supply.
This form of monetary policy has existed for decades. For example, the Federal Reserve pegged interest rates during World War II.
Examples of YCC Programs
During World War II, massive borrowing by the U.S. federal government was necessary to fund the war effort. However, this threatened to send interest rates soaring, making such debt increasingly more burdensome to service. In response, from 1942 to roughly 1947, the Fed successfully kept the government's borrowing costs down by purchasing any government bond that yielded more than certain targeted rates. Notably, the government was able to reach its goals with relatively modest bond purchases.
More recently, the Bank of Japan (BoJ) shifted in late 2016 from a policy of QE to one of YCC, in which it sought to peg the yield on 10-year Japanese Government Bonds (JGBs) at 0%, in a effort to stimulate Japan's economy. Whenever the market yields on JGBs rise above the target range, the BoJ purchases bonds to push the yield back down. So far, the BoJ has been purchasing bonds at a slower pace than under QE.
Japan implemented YCC in the late 2010s as part of its efforts to combat deflation and stimulate economic growth as the BOJ aimed to keep it around zero percent. While YCC in Japan has contributed to low long-term interest rates, there have been concerns about the side effects and limitations of this policy. Critics argue that YCC in Japan has led to market distortions, compressed yields, and impacted profitability.
Does YCC Work?
Pointing to the recent BoJ experience, advocates of YCC believe that the Fed also can achieve lower interest rates with a much smaller balance sheet than it built under QE. Not everyone is confident that YCC will work. An opinion piece in Bloomberg has described YCC as a "bond trader's nightmare," citing lengthy periods in which JGB trading has ground to a halt. Moreover, YCC could spur companies to increase their already heavy debt loads, while punishing pension funds and other savers.
Advocates of yield curve control, also called YCC, argue that, as short-term interest rates approach zero, keeping longer-term rates down may become an increasingly more effective policy alternative for stimulating the economy.
Also, this approach could help prevent a recession or lessen the impact of a downturn. Richard Clarida and Lael Brainard, current members of the Board of Governors at the Fed, as well as former Fed chairs Ben Bernanke and Janet Yellen have said that the Fed should consider using yield curve control. Jerome Powell, the current Fed chair, also has said that he is potentially open to this policy option.
For example, The Reserve Bank of Australia (RBA) implemented YCC during the COVID-19 pandemic in 2020. The RBA targeted the three-year Australian government bond yield, aiming to keep it around a specific low level. The objective was to support the economic recovery by ensuring that borrowing costs remain low for households and businesses. YCC in Australia has been credited with providing stability to longer-term interest rates, encouraging borrowing, and stimulating investment, though detractors also point out its faults.
How Does YCC Work?
YCC works by the central bank setting a target level for yields on specific government bonds and intervening in the bond market through bond purchases to keep yields close to the desired level.
What Impact Does YCC Have on Inflation?
YCC can impact inflation by influencing inflation expectations. By signaling a commitment to achieving inflation targets through low long-term rates, YCC can potentially support the desired level of inflation.
Is YCC a Permanent Policy Measure?
YCC is typically considered a temporary measure. Its duration depends on the central bank's assessment of economic conditions, policy effectiveness, and the need for maintaining stability in long-term interest rates.
What Are the Challenges of Exiting YCC?
Challenges of exiting yield curve control include the need for careful communication and implementation to avoid market disruptions and volatility. The timing and pace of unwinding YCC can significantly impact long-term interest rates and financial market stability.
The Bottom Line
Yield curve control is a monetary policy strategy employed by central banks to target and manage specific yields or interest rates on government bonds. It aims to stabilize long-term interest rates, influence borrowing costs, and promote economic growth. YCC involves the central bank setting a target level for yields and intervening in the bond market through bond purchases to keep yields close to the desired level.
