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.
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.
- 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.
How YCC and QE Differ
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.
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.
Advantages and Disadvantages of YCC vs. QE
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.