QuickTake Q&A: Why Japan’s Central Bank Targeted the Yield CurveBy
The Bank of Japan is seeking to control the yield curve in the latest iteration of its unprecedented stimulus efforts. Governor Haruhiko Kuroda started on his quest toward a 2 percent inflation target by announcing massive asset purchases in 2013. He expanded those in 2014, before introducing negative interest rates in January of this year. Japan is doing everything it can to pull out of deflation -- inflation below 0 percent, with prices dropping across a wide range of goods.
1. What’s the yield curve?
It’s the relationship between yields across different maturities on fixed-rate debt from the same issuer -- in this case, government bonds. In a healthy economy, shorter-term securities will usually have lower yields, reflecting their lower risk to investors.
2. What does the BOJ hope to do?
Under a new policy called “Yield Curve Control,” the central bank adopted a target of around zero percent for the 10-year government bond yield. Zero may sound low, but it’s higher than the recent negative yields seen on those securities. The central bank is countering a flattening of the yield curve, which it says may have a negative effect on economic activity.
3. What determines the shape of a yield curve?
Public confidence or worry, among other things. Investors can be fairly certain the money they get back after three months will be worth about what it is now, but inflation, currency movements or default risks are all a lot harder to predict over a longer span. Curves steepen -- meaning long-term yields rise relative to shorter yields -- or flatten as perceptions of risk change. A flatter curve generally means caution about growth and a weaker inflation outlook. If the curve inverts -- if 10-year yields fall below three-month ones, for instance -- an economy may be heading into a recession.
4. How does the yield curve affect the economy?
A bank considering a five-year loan can look at the government yield as a starting point and then scale up what it charges based on how risky the borrower is. Banks also can use the curve to their advantage, borrowing cheap short-term cash and lending it out at higher longer-term rates, so a steeper yield curve favors bank margins. Businesses can look at government bonds as a way of gauging their own investments. If the return on an investment is judged to be 5 percent a year, and five-year government bonds offer 1.2 percent (as they do in the U.S.), the investment might be deemed a good one.
5. What motivated the BOJ’s decision?
The Bank of Japan has faced rising concern that 3 1/2 years of unprecedented easing has failed to lift the economy in a sustainable way out of a two-decade deflationary spiral. When it introduced negative interest rates in January, it said this would spur economic activity by making it cheaper for businesses and consumers to borrow. Instead, bank margins got squeezed, their profits dropped and shares slumped.
6. Have yield curves been targeted before?
Yes. In 2011-2012, the U.S. Federal Reserve spent some $667 billion on “Operation Twist” -- swapping short-term Treasury securities for longer-term government debt in an effort to flatten the U.S. yield curve. (The goal was to lower long-term interest rates to spur investment, bank lending and the housing market.) The gap between two- and 10-year yields shrank to the narrowest in five years. From 1942 to 1951 the Fed capped the yield on long-term bonds to support government financing during World War II.
The Reference Shelf
- QuickTake explainers on Kuroda’s quest for inflation, Abenomics and deflation.
- Interactive graphic showing what’s wrong with Japan’s economy.
- A Bloomberg View column on the trouble with predictions based on the yield curve.
- Bank of Japan statement introducing yield curve control; statement introducing its new easing policy and later explanation from BOJ on introduction of negative interest rates.
- Federal Reserve paper on Targeting the Yield Curve: The Experience of the Federal Reserve, 1942-51.
- Discussion paper from the central bank on the bursting of Japan’s asset bubble.
- A story on the Japanese bond rout in the leadup to the BOJ meeting,
- IMF research on the risk of deflation in the euro area and IMF Managing Director Christine Lagarde’s speech calling deflation an “ogre.”