12/31/22, 12:01 PM Japan’s Experience with Yield Curve Control

Japan’s Experience with

Yield Curve Control
In September 2016, the Bank of Japan (BoJ)
changed its policy framework to target the
yield on ten-year government bonds at
“around zero percent,” close to the prevailing
rate at the time.
By blog author
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Matthew Higgins and Thomas Klitgaard

In September 2016, the Bank of Japan (BoJ) changed its

policy framework to target the yield on ten-year
government bonds at “around zero percent,” close to the
prevailing rate at the time. The new framework was
announced as a modification of the Bank’s earlier policy
of rapid monetary base expansion via large-scale asset
purchases—a policy that market participants

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increasingly regarded as unsustainable. While the BoJ

announced that the rapid pace of government bond
purchases would not change, it turned out that the yield
target approach allowed for a dramatic scaling back in
purchases. In Japan’s case, the commitment to
purchase whatever was needed to keep the ten-year
rate near zero has meant that very little in the way of
asset purchases have been required.

Easy Monetary Policy but Stubbornly Low Inflation

Inflation began falling in Japan after the collapse of the

so-called “Bubble Economy” in the early 1990s. By 1994,
core inflation (a measure that excludes fresh food and
energy prices) was running below 1 percent. The BoJ
responded with aggressive rate cuts. By 1995, its main
policy rate had been slashed to 0.5 percent, a then-
unheard-of level. In late 1999, the policy rate was
pushed down to zero, but outright deflation had already
set in, with the core consumer price index falling by
almost 1 percent annually from 1999 to 2002.

A central bank’s ability to moderate the business cycle

depends on controlling the real rate of interest—that is,
the nominal rate adjusted for inflation. If inflation is stuck
at too low a level, even a policy rate of zero may not be
enough to revive the economy. As a consequence,
pushing inflation into positive territory is important
because it provides room for countercyclical monetary
policy.

In March 2001, the BoJ stepped up its fight against

deflation by adopting a program of quantitative easing.
Under the new policy, the Bank stepped up its purchases
of Japanese government bonds (JGBs) and other assets
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in order to expand the monetary base, which consists of

banks’ reserve balances plus currency in circulation.
(Since central banks purchase assets by crediting banks’
reserve accounts, an expansion of the monetary base
follows automatically.) Compared with what other central
banks would undertake in the wake of the global
financial crisis, the BoJ’s asset-purchase program was
fairly small.

By March 2006, when the program was halted, the BoJ’s

asset holdings had increased from ¥110 trillion to more
than ¥150 trillion (equivalent to about 30 percent of
Japanese GDP at the time). While the BoJ’s policy board
stated that inflation was now “consolidating a positive
trend,” core inflation stood at -0.6 percent, and even the
BoJ’s then-preferred measure of inflation (excluding only
fresh food) was just 0.1 percent. A series of smaller
quantitative easing measures were implemented from
2010 through early 2013.

In April 2013, the BoJ adopted a “shock and awe”

strategy called Quantitative and Qualitative Easing
(QQE). The new policy had several elements: first, a
commitment to massive asset purchases, largely of
JGBs, that would increase the monetary base by ¥60-70
trillion per year; second, a commitment to lengthen the
maturity of its JGB holdings, in an explicit attempt to
lower long-term rates and flatten the yield curve; finally,
a pledge to stick with the new policy until inflation was
firmly at or above the BoJ’s 2 percent target. A little over
a year later, the asset purchase commitment was raised
to ¥80 trillion.

The BoJ’s balance sheet grew rapidly. Holdings of JGBs

rose from ¥140 trillion in April 2013 to ¥380 trillion by
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August 2016. The monetary base rose by a similar

amount. The scale of this monetary expansion is hard to
overstate. By August 2018, the monetary base stood at
roughly 90 percent of GDP, three times the initial ratio.
Asset purchase programs in the United States and the
euro area, themselves unprecedented, never pushed the
monetary base as high as 30 percent of GDP.

There were early signs that QQE was working in Japan.

Yields on ten-year government bonds fell significantly,
from about 0.75 percent prior to the program to about
0.25 percent by late 2015. Unemployment fell steadily,
signaling that the economy was growing above its
potential pace. Core inflation rose from -0.6 percent
when the policy was adopted to 1.2 percent by late
2015.

But the good news did not last. Core inflation fell back to
just 0.5 percent by mid-2016. Market measures of long-
term inflation expectations also declined. Moreover, the
BoJ now held almost 40 percent of the JGB market. With
this share steadily rising, dealer surveys pointed to a
deterioration in JGB market functioning. Finally, the ten-
year yield on JGBs fell into clear negative territory in
early 2016, soon after the BoJ cut its main policy rate
(the deposit rate on marginal excess reserves) from 0.1
percent to -0.1 percent. Many market analysts worried
that long-term rates might stay well below zero for some
time, compressing lending margins and undermining the
financial strength of banks and insurance companies.

A New Framework
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In September 2016, the BoJ introduced a framework it

labeled Quantitative and Qualitative Easing with Yield
Curve Control (QQE with YCC). The BoJ reaffirmed that
the rapid pace of asset purchases would continue until
inflation had moved above its 2 percent target “in a
stable manner.” But now, the BoJ would also set a target
for ten-year JGB yields of “around zero percent,” near
the prevailing rate at the time. While it was not part of
the announcement, markets soon inferred that this
involved a fluctuation band of ±10 basis points.

The effects of YCC were quickly evident in financial

markets. As seen in the chart below, ten-year JGB yields
settled close to the target and remained remarkably
stable over the next two years. Yield volatility, already
much lower than in the U.S. or German markets,
declined even further, with the standard deviation of
monthly changes falling by about half relative to the
QQE period. Volatility did pick up after the BoJ widened
the ten-year yield fluctuation band to ±20 basis points in
July 2018, but remained low relative to the volatility seen
in Japan during the QQE period and contemporaneously
in other countries.

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BoJ Credibility Allowed for a Substantial Reduction in

JGB Purchases

Yield curve stability has come with a marked decline in

the pace of BoJ asset purchases, despite the Bank’s
statements that it was leaving its earlier purchase target
unchanged. As seen below, the Bank’s JGB holdings
have risen by just ¥100 trillion in the nearly four years
since YCC was introduced, and by roughly ¥20 trillion
over the past twelve months. In essence, maintaining the
rate target has become delinked from the pace of
balance sheet expansion. Consistent with the reduced
pace of BoJ purchases, dealer surveys of JGB market
functioning have turned notably less negative.

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The reduced pace of asset purchases reflects the

credibility of the BoJ’s commitment to the ten-year yield
target. After all, the Bank has essentially unlimited
buying power, and can thus always purchase the
quantity of JGBs needed to keep yields near zero.

Success?

Has YCC been a success? Seemingly not on the

inflation front, at least thus far. Core inflation has been
running near 0.5 percent in recent months, barely higher
than when the policy was adopted. The challenge for the
BoJ is that expectations for persistently low inflation are
entrenched. Banks were awash with liquidity when YCC
started and long-term yields were already near zero. If
monetary stimulus alone had the power to push
Japanese inflation up to 2 percent, it likely would have
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happened already under QQE. Of course, we don’t know

what inflation would have been without YCC. It should
also be noted that the unemployment rate before the
COVID-19 outbreak was near historic lows, so there was
the possibility that continued labor market tightness
would have eventually pushed inflation higher.

Any central bank considering a move to implement its

own version of YCC —as the Reserve Bank of Australia
did recently—has many questions to ponder. What rate
is targeted? How much should rates be allowed to vary
around the target? What guidance should be offered
about the conditions under which the target rate and
range might change? And, ultimately, does YCC help a
central bank achieve its policy goals?

For Japan, the jury is still out on this last question. Still,
YCC has had one clear benefit. Under the new policy,
the BoJ has been able to exert fairly close control over
the term structure of interest rates without resorting to
large-scale interventions in the JGB market. Investors
accept that the Bank can buy whatever quantity of JGBs
is needed to keep yields from rising and, as a result, it
has not had to buy many at all.

Matthew Higgins is a vice president in the Federal

Reserve Bank of New York’s Research and Statistics
Group.

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Thomas Klitgaard is a vice president in the Bank’s

Research and Statistics Group.

How to cite this post:

Matthew Higgins and Thomas Klitgaard, “Japan’s

Experience with Yield Curve Control,” Federal Reserve
Bank of New York Liberty Street Economics, June 22,
2020,
https://libertystreeteconomics.newyorkfed.org/2020/06/japans-
experience-with-yield-curve-control.html.

Disclaimer

The views expressed in this post are those of the

authors and do not necessarily reflect the position of the
Federal Reserve Bank of New York or the Federal
Reserve System. Any errors or omissions are the
responsibility of the authors.

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