Yield Curve Control Sustainability

Megan Greene recently wrote [the] “Bank of Japan Needs the Courage to Change Course” at the Financial Times. I would summarise the piece as a fairly conventional analysis discussing the apparent “need” to end yield curve control (YCC). The statements at the end raised the eyebrows of an MMT proponent that forwarded the link to me. For example:

To minimise disorder, the BoJ should be clear about its reaction function and move slowly but deliberately by first further widening the YCC band or targeting a shorter duration. Ultimately, it must [emphasis mine] announce that it is abandoning YCC entirely and will instead aim to minimise rapid changes in debt prices, such as those seen in the UK government bond market in September.

The problem is the “must”: it suggests that ending YCC is inevitable. From my perspective, there are a few layers to the response to that assertion.

1. The theoretical response is that there is no necessity to end YCC: it is a sustainable policy — assuming that other parts of the policy framework (including fiscal policy) are coherent with it. (For example, if inflation actually gets serious, something other than interest rate policy would be needed to combat inflation.)
2. The realpolitik answer is that YCC is not sustainable if the central bank does not want to sustain it, and it is not mandated to do so.

From the perspective of MMT proponents, the ideal case is that Japan embraces MMT and seriously considers alternative policy frameworks to control inflation. This allows them to keep YCC in place — which is close to a MMT policy recommendation. The MMT policy recommendation is for the fiscal arm of the government to stop issuing bonds completely, while YCC just has central bankers using government bond yields as a control variable. The difference is that YCC gives the central bank the discretion to effectively end the policy at will.

An equivalent to this situation would be an “inflation target” that lets the central bank decide each quarter what the target would be, as opposed to a specific target that is mandated. (Part of the unsatisfactory nature of U.S. policymaking is that Congress gave the Fed too much wiggle room to interpret their mandate. Leaving the target to the “experts” is fine so long as the objectives of macroeconomic policy are not politically contested — but the United States has not had anything resembling a consensus on those matters since the mid-1990s, if not earlier.)

Why stop issuing bonds? The reasoning depends upon political arguments: it ends the whole “bond vigilantes vetoing government policy” debate. There is no chance of default, so fiscal conservatives will have to deal with real issues around spending, and not rely on fear tactics.

There are a few take-aways from this topic on how to respond.

• An MMT proponent would prefer that Japan adopt the MMT framework, and keep YCC as part of a wider reform of macroeconomic stabilisation policy.
• A disinterested observer just needs to know that YCC can be “sustained” — the issue is the political willingness of the BoJ to hold the target in face of pressure. I am not following Japan closely enough at this point to have an opinion on that matter.
• A cynical realist (like myself…) would prefer that if YCC is abandoned, it is done in a non-dramatic fashion. As the Canadian Establishment demonstrated in 1994, it is easy for policy makers to manufacture a “crisis” by the expedient tactic of just making stuff up. Saying that “the bond vigilantes forced us to do X” is great political cover for policy makers who wanted to do X in the first place. If the BoJ does not really want to sustain YCC — and once again, I have no idea what their internal thinking is on the matter — doing it when markets are quiet is the way to go.

I am not really in the policy advocacy business, rather I prefer to discuss what the options are. The mainstream has blundered into YCC as a way to replace their broken short-term policy rate lever. There was essentially no (conventional) alternative, since the main effect of QE was to fuel crackpottery. Yield curve control feels fine when short rates are pinned at the effective lower bond — but is much less politically attractive if you want to attempt to micromanage the economy by changing bond yields. People squawk when the central bank hands them capital losses as a matter of policy.

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(c) Brian Romanchuk 2022