Yield curve control
One of the pillars of Bank of Japan’s current approach to monetary policy has recently come under fairly sharp rebuke from the keepers of the international order. At issue is yield curve control, so called because the central bank targets not only an overnight interest rate but also a term rate, ten years out on the yield curve. YCC has been, in practice, a highly accommodative form of quantitative easing. With prices in the country now rising after decades of outright or near-deflation, the policy has taken criticism from various angles, including last week from the IMF’s Gita Gopinath.
The moniker “yield curve control” captures only the policy’s intended outcome. How the BoJ brings that outcome about is worth spelling out. Today, three graphs that help to clarify Japan’s monetary policy.
The central bank’s balance sheet
This graph shows the balance sheet of the Bank of Japan over a rather long horizon, from 1998 to the present. As always, assets are shown above, liabilities as negative numbers below. All of the BoJ’s assets and liabilities are accounted for, so the picture is perfectly symmetrical: the balance sheet balances. One can see from the form of the graph that the BoJ has gone through several approaches to monetary policy, mostly in an effort to reverse decades of falling prices.
In 2012, under the banner of Abenomics, the bank embarked on a major period of balance sheet expansion, more slowly after 2017, and more quickly again in 2020. The expansion has come mostly in the form of purchases by the BoJ of the country’s sovereign bonds (i.e., JGBs), and to a lesser extent in the form of lending to the Japanese banking sector. The funds created by this process end up as bank reserves, a liability to the BoJ (and an asset to the banks).
Sell money, buy credit
Yield curve control, the specific policy measure that has been at issue lately, was introduced in 2016. The pivot isn’t really visible on the balance sheet: there, 2016 looks more like continuity. What changed was the term structure of asset purchases. The effect is visible in this graph of three-month and ten-year JGB yields. From 2016 forward, the ten-year yield was brought down to near zero.
Short yields came up at the same time, eventually settling around an eighth of a point for the three-month bill shown here. The ten-year yield was brought down below this rate. To achieve this, the BoJ has had to be ready to buy enough government bonds to keep ten-year bond prices high, and yields low.
At those yields, most everyone other than the BoJ would prefer not to lend to the Japanese government. This helps make sense of a change in the policy in December. The target for the ten-year rate was and still is zero, but with a trading band around it. That band was plus or minus 25 basis points until last month, when the central bank widened it unexpectedly to 50 basis points. But the market is lopsided at the moment, so widening the band is, under current market conditions at least, a way of allowing ten-year rates to rise.
The result is this yield curve. It has a kink at the ten-year mark, but the rest of the curve is quite smooth. The BoJ must be buying and selling not only ten-year bonds, but also elsewhere along the curve to keep it nicely shaped.
Under control?
This set of policies is now coming in for criticism from abroad for being too accommodative. The BoJ is still trying to increase the price level, while the rest of the world’s central banks are doing the opposite. The IMF, in particular, has suggested the Japanese central bank is offside. The Fund is pushing for changes to the YCC policy to reduce the flow of bond purchases. Mark this as a hairline fault that has opened up among the world’s top monetary authorities.