Yield-curve control

published 25 December 2020

In “normal” times, central banks try to stimulate (or cool down) the economy by cutting or raising short-term interest rates, and thus wider borrowing costs. But since the 2008 financial crisis interest rates across the developed world have been stuck at near-0%. So central banks have experimented with more extreme monetary policies, such as quantitative easing (QE – printing money to buy government bonds and other assets). “Yield-curve control” is one such policy.

A yield curve compares the yields on bonds with the same credit quality across lengthening maturities. So the Treasury yield curve shows how interest rates on US government debt change as the repayment date gets further away. A healthy yield curve slopes upwards from left to right – bonds with longer maturities yield more than short-term ones. That makes sense, because in normal circumstances you expect to get paid more to wait for your money.

Yield-curve control is when a central bank aims to control long-term interest rates by pledging to buy (or sell) as many long-term bonds as needed to hold rates at a certain level. This is a form of “financial repression”. By capping bond yields at a level below inflation, government debt becomes easier to repay, but life becomes harder for savers. A key question, as Steve Russell notes on page 29 in this week’s MoneyWeek Roundtable, is how high inflation has to go in this scenario before investors feel that high asset prices can no longer be justified purely by interest rates being at or near 0%.