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Central bank policy sets the lower bound on bond yield

Author

Listed:
  • Joseph E. Gagnon

    (Peterson Institute for International Economics)

  • Olivier Jeanne

    (Peterson Institute for International Economics)

Abstract

This paper shows that the scope for bond yields to fall below zero is strictly limited by market expectations about how far below zero central banks are willing to set their short-term policy rates. If a central bank communicates a credible commitment to keeping its policy rate above a given level under all circumstances, then bond yields must be higher than that level. This result holds true even in a model in which central banks are able to depress the term premium in bond yields below zero via large-scale purchases of long-term bonds, also known as quantitative easing (QE). QE becomes less effective as bond yields approach their lower bound.

Suggested Citation

  • Joseph E. Gagnon & Olivier Jeanne, 2020. "Central bank policy sets the lower bound on bond yield," Working Paper Series WP20-2, Peterson Institute for International Economics.
    • Handle: RePEc:iie:wpaper:wp20-2
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    More about this item

    Keywords

    Negative interest rate; quantitative easing;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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