Yield curve control entails financial instability – Natixis

Central banks in OECD countries are explicitly (the case in Japan, probably soon in the US) or de facto (in the Eurozone) switching to a policy of controlling long-term interest rates, otherwise known as “yield curve control”. A clear consequence of this choice of yield curve control is financial instability: asset price bubbles, rising debt and high variability in asset prices, according to economists at Natixis.

Key quotes

“The slope of the yield curve no longer responds to its usual determinants. As long-term interest rates are controlled, they no longer react to changes in public debt or expected inflation.”

“The central bank’s money supply can no longer be controlled; it becomes endogenous. This is because central banks have to supply the quantity of money that is necessary, by buying bonds, to lower the long-term interest rate to the desired level.”

“Once inflation normalises after the COVID crisis as the economy gets going again, stocks are reduced and commodity prices rise, real long-term interest rates will be persistently negative, as nominal long-term interest rates will remain low.”

“Negative real long-term interest rates will lead to strong rises in equity valuation and real estate prices; there will also be a strong incentive to borrow.”

“In the event of a demand shock (positive or negative), it will no longer be corrected by a change in long-term interest rates, leading to high variability in asset prices and in GDP growth.”