ON THE ECONOMY | AUGUST 2020

https://www.stlouisfed.org/on-the-economy/2020/august/what-yield-curve-control

What Is Yield Curve Control?

By Kevin L. Kliesen; Research Officer and Business
Economist; and Kathryn Bokun, Research Associate

Traditionally, the Federal Open Market Committee

(FOMC) targets the federal funds rate as a primary
tool to conduct monetary policy. The fed funds rate
is a rate with a very short maturity. Movements in
the fed funds rate—which is an overnight interest
rate rate—are thought to influence longer-term
rates. Based on the most recent Summary of
Economic Projections, the FOMC expects to keep
the fed funds rate at zero through 2022. This has led
to discussion of additional tools to conduct
monetary policy with the federal funds rate effectively at zero. One of these policies that has received some
attention in the press: yield curve control (YCC).1

How Does Yield Curve Control Work?

Similar to a policy rate, YCC aims to control interest rates along some portion of the yield curve. The yield
curve is usually defined as the range of yields on Treasury securities from three-month Treasury bills to 30-
year Treasury bonds. However, YCC targets longer-term rates directly by imposing interest rate caps on
particular maturities. Because bond prices and yields are inversely related, this also implies a price floor for
targeted maturities. If bond prices (yields) of targeted maturities remain above (below) the floor, the central
bank does nothing. However, if prices fall (rise) below (above) the floor, the central bank buys targeted-
maturity bonds—increasing the demand and thus the price of those bonds.

The minutes of the FOMC meeting on June 9-10 noted that the staff highlighted three examples of YCC
policies: Federal Reserve policy during and after World War II, the Bank of Japan’s policy adopted in 2016
and the Reserve Bank of Australia’s policy adopted in March 2020.

YCC in the U.S.

The U.S. incurred massive debt expenditures to finance World War II, and the Fed capped yields in order to
keep borrowing costs low and stable. In April 1942, short- and long-term (25 years and longer) interest rates
were pegged at 3/8 percent and 2.5%, respectively. These rate caps were largely arbitrary and were set at
approximately pre-1942 levels.

As the U.S. continued to incur debt, the Fed was obligated to keep buying securities to maintain the targeted
rates—forfeiting some control of its balance sheet and the money stock. The public generally preferred to
hold higher-yielding, longer-term bonds. Consequently, the Fed purchased a large amount of short-term
bills, which also increased the money supply, to maintain the low interest rate peg.

After the war ended, FOMC members grew more concerned with addressing the rapid inflation that
materialized. However, President Harry S. Truman and his treasury secretary still favored a policy that
maintained YCC (which also protected the value of wartime bonds by implying a price floor). By 1947,
inflation was over 17%, as measured by the year-over-year percent change in the consumer price index
(CPI), so the Fed ended the peg on short-term rates in an attempt to combat developing inflationary
pressures.

In combination with rising debt from the U.S. entering the Korean War in 1950, the peg on longer-term rates
contributed to faster money growth and increased inflationary pressures. In 1951, annualized inflation was
over 20%, and monetary policymakers insisted on combating inflation. Against the desires of fiscal
policymakers, interest rate targeting was brought to an end by the Treasury-Fed Accord in March 1951.

YCC in Japan

The Bank of Japan implemented YCC in 2016 with the goal of exceeding its 2% inflation target. The short-
term policy rate and 10-year rate on government bonds were set at -0.1% and zero percent, respectively.

YCC complements Japan’s quantitative and qualitative monetary easing (QQE) and negative interest rate
policies. QQE policy resulted in annual bond purchases of about 100 trillion yen until 2016—sharply
increasing the size of the Bank of Japan’s balance sheet. QQE with YCC lowered bond purchases to about
70 trillion yen in 2019. Additionally, the monthly inflation rate, as measured by the year-over-year percent
change in the CPI, has remained above zero since enacting YCC.
YCC in Australia

More recently, the Reserve Bank of Australia (RBA) implemented YCC. Since its announcement on March 19,
2020, the RBA has purchased bonds worth 52 billion Australian dollars to maintain the 0.25% target on
three-year bonds. The bulk of purchases occurred between March 19 and May 6; purchasing stopped until
August 5-6, when the central bank purchased 1 billion Australian dollars, as the three-year yield was slightly
above the target. Further purchases will continue if the yield deviates from the target rate. The yield
generally stays within 5 basis points of the target, as shown in the figure below.
Costs and Benefits
Current experiences in Japan and Australia, as well as the Fed’s experience in the 1940s, suggest that YCC
has been an effective tool at targeting interest rates along some portion of the yield curve. As the minutes of
the June FOMC meeting noted, the lessons from these three episodes suggest that a YCC policy can be
implemented in such a way as to avoid a significant expansion in the central bank’s balance sheet—
assuming the absence of an explicit exit strategy designed to reduce the size of the balance sheet. However,
those minutes also noted that many FOMC participants had remarked that it was not clear there would be a
need to adopt YCC as long as forward guidance remains credible on its own.

However, it is important to acknowledge that every policy has drawbacks. For example, if the Fed were to
adopt such a policy 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.

Another worry is that YCC could distort market signals, thereby diminishing the value of information that
monetary policymakers glean from the Treasury market. Finally, if the Fed were to adopt YCC, policymakers
would have to grapple with the challenge of how to exit from policies designed to be temporary departures
from normal. Thus, once the economy normalizes, it would be important to convey the YCC exit strategy to
the public in a clear manner to avoid potentially destabilizing outcomes.

Complementing Other Policies

Overall, YCC can complement other policies, such as quantitative easing and forward guidance, especially
when a central bank’s nominal interest rate target is near zero. The policy can thus help align market
expectations with the FOMC’s expectations. Nevertheless, there are other risks associated with YCC,
including potential threats to central bank independence and the requirement that the market believe that
the central bank would keep interest rates on a path consistent with its target. Credibility is thus key to YCC
—or any policy, for that matter.

Notes and References

1. Yield curve control is also sometimes referred to as yield curve targeting or yield curve caps.

Additional Resources
Open Vault: Understanding the Role of Monetary Policy in the Economy
On the Economy: A Primer on Negative Interest Rates