Central bank policy sets the lower bound on bond yield

Joseph Gagnon and Olivier Jeanne

No WP20-2, Working Paper Series from 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.

Keywords: Negative interest rate; quantitative easing (search for similar items in EconPapers)
JEL-codes: E43 E58 G12 (search for similar items in EconPapers)
Date: 2020-01
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:iie:wpaper:wp20-2

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