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Groping for new tools, central banks look at Japan's yield controls

Economy Jul 15, 2019 01:48AM ET
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By Leika Kihara, Howard Schneider and Balazs Koranyi

TOKYO/WASHINGTON/FRANKFURT (Reuters) - Japanese-style interest rate caps are drawing interest from global central bankers worried about a downturn, including U.S. Federal Reserve officials grappling with how to bolster their options as prospects for the global economy darken.

A departure from the classic focus by central banks on short-term rates, the Bank of Japan's "yield curve control" initiative aims to anchor longer-term rates that often more directly influence consumer borrowing costs and spending.

The BOJ has been receiving queries from several central banks, including the Fed, on how the unconventional program works, sources familiar with the matter said.

Several top Fed officials have discussed the notion in recent months as the U.S. central bank reviews how it conducts policy, including governors Lael Brainard and Richard Clarida. Brainard said she "would like to hear more about it" even as she is far from embracing it as an option.

The interest speaks to the dilemma faced by the world's big three central banks - the Fed, BOJ and European Central Bank. The Fed alone among them has been able to raise interest rates reasonably away from zero since the 2007-2009 financial crisis, but even it is about to begin lowering them in response to global weakness and persistently low inflation.

Globally there is a recognition that if the major economies have all gravitated together toward a weak-inflation, low-growth, and low-interest-rate world, textbook central banking may be dead - with no clear substitute at the ready.

"I am open minded about a whole slew of policy alternatives," Chicago Federal Reserve Bank President Charles Evans said. "What's most critical is that whatever we do we are able to demonstrate that with that tool we are out to achieve our mandate and that tool is set properly."


The Fed, BOJ and ECB all dived headlong into unconventional policy to combat the crisis. Each bought trillions of dollars in financial assets to flood their economies with cash in programs called quantitative easing, an effort seen likely to be repeated in the future even as its effectiveness is debatable.

The BOJ, though, has pushed the bounds of convention further than the others. Three years ago, with short-term rates already pushed into negative territory to little effect, it launched a bold experiment to anchor long-term interest rates near zero in a bid to breathe life into an anemic consumer spending scene.

Under yield curve control, the bank targets a rate at a specific maturity. It buys whatever quantity of securities is needed to hit that, a goal easy to communicate to the public and easy for businesses and households to plan around.

The Fed's Brainard discussed the concept at a Fed event in May.

"Once the short-term interest rates we traditionally target have hit zero," she said, "we might turn to targeting slightly longer-term interest rates - initially one-year interest rates, for example, and if more stimulus is needed, perhaps moving out the curve to two-year rates."

In Japan it has had some success, albeit mixed.

Yields on 10-year Japanese government bonds (JP10YT=RR), the point on Japan's yield curve targeted by the BOJ, have mostly held near its objective. Retail sales have risen year-over-year in all but one of the last 31 months, a run not seen in Japan since the early 1990s.

Inflation, though, has come nowhere near the BOJ's 2% target, and some worry the program is damaging that effort.

"There's a risk that by capping long-term rates, central banks could hurt, not heighten, inflation expectations," said Mizuho Research Institute executive economist Kazuo Momma, a former BOJ executive.


Keeping long-term rates in line could create other hazards for the Fed. An abrupt spike in yields could force the central bank to purchase Treasuries in amounts that could leave officials open to the type of criticism they heard from many quarters for quantitative easing.

The BOJ was forced to offer to buy unlimited amounts of bonds at 0.11% in July 2018 to prevent long-term rates from rising above target when the 10-year yield was creeping up as global yields rose while the Fed was raising rates.

For the BOJ, putting a floor on yields has proved even trickier, as reducing bond buying too much, in order to raise a flagging interest rate, would contradict its pledge to keep printing money heavily until its inflation goal is met.

Prospects of U.S. interest rate cuts have pushed down yields across the globe, including in Japan, where the 10-year yield slid to a nearly three-year low of -0.195% last month.

"The true test to YCC could come when bond yields remain stuck in negative territory for a long time," said an official familiar with the BOJ's thinking.


The Fed toyed with a version of this in 2011 and 2012 when it sold short-term bonds and bought longer-dated ones in a program called "Operation Twist." It helped drive consumer borrowing costs on items like mortgages to generational lows, and it was a period when inflation actually did rise.

But explicitly targeting long-term yields again may prove politically challenging, renewing concerns about central bank overreach and market intervention.

For the ECB, yield curve control is a no go for a different reason. There is no common euro-area bond it could buy, meaning it would have to decide which country's bond yields to target among the euro zone's 19 members.

If it tried to narrow or target the spread between bond yields in different countries, the ECB could face criticism of protecting profligate governments.

For the Fed, one key would be how much control it could or would want to have over the Treasury market.

Analysts point to the BOJ's huge presence in the JGB market as a key to its success. Years of heavy buying to reflate growth has left the BOJ holding roughly 45% of the market.

The Fed, by contrast, currently holds only about 13% of the $15.9 trillion in marketable U.S. Treasury debt.

"The BOJ has enormous grip on the bond market," said another official with direct knowledge of BOJ policy. "That makes YCC quite a powerful tool."

Groping for new tools, central banks look at Japan's yield controls

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