Central Banks Turn to Japan for Yield Curve Control Lessons

Michael Heath

(Bloomberg) -- As central banks around the world reignite quantitative easing programs or adopt them for the first time, Japan’s key focus of controlling bond yields rather than a quota of purchases is being explored.

When the Reserve Bank of Australia broke the emergency glass on March 19, it set a target for the yield on three-year Australian government bonds of around 0.25%, in line with its benchmark policy rate that was lowered to this level.

The advantage of targeting a yield rather than promising to buy a specific amount of bonds is the greater flexibility it allows monetary authorities. If bond markets behave and yields fall into line with the targets, the program can be easier to manage with fewer purchases needed.

The BOJ adopted that approach in late 2016 -- it targets a 10-year yield around zero -- after its earlier QE program appeared on an unsustainable path given the huge volume of bond buying and resulting market distortions that were involved. Federal Reserve Governor Lael Brainard has floated the prospect for yield curve control in the U.S. recently too.

“The surprise in the RBA package was that it leapt past the Fed and other central banks to take a leaf out of the Bank of Japan’s book,” said Paul Sheard, a senior fellow at Harvard University’s Kennedy School who had a front row seat during Japan’s multi-decade struggle to battle stagnation and deflation as an economist in Tokyo.

The key lesson for Australia is that fiscal policy needs to be a big part of the picture, if not taking the lead, he said.

Fiscal-Monetary Coordination

That’s where lower yields come in, by making it easier for governments to fund their shortfalls -- a factor that has helped Japanese Prime Minister Shinzo Abe cheaply fund years of deficits even while carrying the world’s largest debt-to-GDP ratio.

Australia’s government delivered two stimulus packages within 10 days totaling more than A$80 billion ($48 billion). Such fiscal-monetary coordination is designed to cushion the economic blow from the coronavirus.

To complement his version of yield curve control, RBA Governor Philip Lowe adopted forward guidance, saying he expects to keep the cash rate at its current level for some years. He also announced a funding facility for the banking system to support lending to small- and medium-sized businesses.

What Bloomberg’s Economists Say

“The RBA’s approach has shown it has taken time to learn from the Bank of Japan and other central banks’ unconventional policy approaches. While that’s informed the design of Australian QE, the RBA would also be acutely aware that the ability to unwind QE programs and escape the effective lower bound relies on fiscal policy makers choosing economics over politics and stepping up to revive their economies.”

James McIntyre, economist

The Fed’s Brainard, in a Feb. 21 speech, noted the advantages of yield curve control when complemented by forward guidance.

“One important benefit is that this approach would smoothly move to capping interest rates on the short-to-medium segment of the yield curve once the policy rate moves to the lower bound and avoid the risk of delays or uncertainty that could be associated with asset purchases regarding the scale and timeframe,” she said.

Fed Bazooka

The Fed on Monday unveiled a sweeping series of measures -- but no YCC. It will buy unlimited amounts of Treasury bonds and mortgage-backed securities to keep borrowing costs at rock-bottom levels and to help ensure markets function properly. It also set up programs to ensure credit flows to firms and state and local governments.

Adam Posen, who heads the Peterson Institute for International Economics in Washington and was a crisis-era U.K. policy maker, reckons that while a Fed move to yield curve control isn’t imminent, it is likely to come at some point. He argues the policy enables easy fiscal policy, but the central bank preserves independence because it isn’t judging or responding to a government’s programs.

“Monetary policy is going to shift from keeping credit markets open to keeping rates low but positive,” Posen says. “They can all learn from the Bank of Japan’s yield curve control. When governments are doing repeated fiscal expansion, this is the least politically fraught and most transparent way to accommodate fiscal policy.”

Australia escaped the financial crisis of 2008 without a recession or the RBA needing to adopt what was then known as “unorthodox” monetary policies. That meant it was able to observe the experience of other central banks including the Fed, BOJ, Bank of England and European Central Bank. Lowe, for instance, has ruled out negative interest rates, all too aware of their adverse side effects on banks and asset managers.

Policy makers Down Under expect that they will need to buy bonds to help achieve the target yield level and keep markets functioning smoothly but, the announcement effect and market credibility will assist the bank. Another plus: Australia’s stock of outstanding government debt isn’t nearly as large as some global peers because its budget deficits haven’t been as deep, meaning they can probably manipulate yields with fewer purchases.

Such factors may also make it easier for Lowe and his team to eventually exit unconventional policy, once the economy perks up.

Lowe’s view that Australia would be able to stick to conventional rates policy this year was shattered by the spread of coronavirus, which has some economists predicting unemployment will soar to 11% and the economy slump into recession for the first time since 1991.

There are some key differences between Australia and Japan’s policies too. The latter came to yield curve control in 2016 after many years of quantitative easing and an entrenched deflationary mindset that Governor Haruhiko Kuroda continues to wrestle with today.

Japan also has a short-term policy balance rate of minus 10 basis points, so targeting the 10-year yield of around zero is meant to give a slightly positive slope to the curve. Lowe wants a flat curve over three years.

David Plank, head of Australian economics at Australia & New Zealand Banking Group Ltd., says the key similarity is likely to be the “Hotel California” experience that has confronted most central banks that embark on non-conventional monetary policy.

“Namely, that once you’ve started you can never leave,” he said.

(Updates with comment from Bloomberg economist in 10th paragraph.)

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