ECB View: Explicit yield curve control unlikely given the success of implicit policy – Pablo Hernández de Cos, ECB Governing Council member and Governor of the Bank of Spain, has suggested that the central bank should consider a policy of yield curve control. He noted that ‘the experience of (other) central banks suggests that, if sufficiently credible, yield-curve control allows the central bank to achieve a yield-curve configuration with a lower amount of actual purchases, hence, enhancing efficiency’. This has been indeed the experience of the BoJ, which has a target for the 10-year yield. Meanwhile, other central banks – both currently and in the past – have targeted shorter-maturity yields as way to re-enforce forward guidance on policy rates remaining steady over that period.
How would the ECB conduct such a policy and how likely is it? The complication in the eurozone context compared to other central banks is that there is not a single government bond market. So the first question that arises is what yield the ECB would target. One option for the ECB would be to use a GDP-weighted average of government bond yields in the eurozone. Indeed, this is a concept that the ECB uses as the technical assumption for bond yields behind its macro projections. That would avoid the ECB targeting the yield of any particular sovereign security. However, a drawback is that as well as an overall yield level, the ECB would also like to reduce the dispersion between yields to avoid fragmentation. Nevertheless, this would likely be the case in practice if the average target yield is low enough. So despite the complication of each member state having its own sovereign bond market, a yield curve control framework is possible in the eurozone context.
Having said that, a yield curve control framework with an explicit published target still seems an unlikely development. First, Mr de Cos is one of the few officials that seems supportive of such a move, and there would likely be opposition by other Governing Council members. Second, the Governing Council as a whole might be concerned about legal challenges of a policy where it effectively guarantees unlimited purchases to achieve a specific yield configuration. Third, having an explicit target reduces the ECB’s flexibility, both in terms of its exit strategy but also in a situation where the central bank struggles to cap yields at a very specific level. It could be argued that the last thing the ECB needs is a second policy target that it never achieves.
A fourth argument articulated in a Fed note (see here) made in the context of the US central bank is that ‘if the Fed were to adopt …(yield curve control)… and if the public perceives that the Fed is engaged in deficit financing, then it is possible that inflation expectations could rise, threatening the Fed’s long-run goal of price stability; this happened in the U.S. in the 1940s and early 1950s and led to the Treasury-Fed Accord in 1951’. Though one does not need to read too much in between the lines of ECB communication to come to the view that the central bank is very clearly in the business of ensuring governments can finance themselves at favourable rates (at least with regards its purchases under the PEPP).
The final and perhaps most important argument against explicit yield curve control is that the ECB is already engaged in a policy of implicit yield curve control and by doing so is reaping the benefits of an explicit policy but avoiding some of the costs. Indeed, the ECB has managed to drive the weighted average yield level in the eurozone to levels below zero and it has actually settled at a very narrow range around -0.2% since the autumn of last year, despite the ECB reducing the pace of public sector purchases after the summer months. (Nick Kounis)