What is forward guidance and Yield Curve Control?
How is it used in the Federal Reserve’s monetary policy?
Forward guidance is a tool that central banks use to provide communication to the public about the likely future course of monetary policy. When central banks provide forward guidance, individuals and businesses will use this information in making decisions about spending and investments. Thus, forward guidance about future policy can influence financial and economic conditions today.
In English: This statement means the Fed is going to tell you want they are planning to and/or thinking of what they are planning to do. They do this so businesses have an idea we where the economy is going in the future and allowing this information to help them position themselves for the coming policy implementation and/or change.
Example: Before increasing its target for the federal funds rate in June 2004, the FOMC used a sequence of changes in its statement language to signal that it was approaching the time at which a tightening of monetary policy was warranted.
In the aftermath of the global financial crisis, the FOMC reduced its federal funds rate target nearly to zero and then used forward guidance to provide information about likely future monetary policy.
The FOMC’s forward guidance has evolved over time; eventually, the Committee’s guidance indicated that the future path of the federal funds rate would depend upon how future economic conditions changed. In addition, the FOMC used forward guidance language about the flow-based asset purchase program that it undertook in September 2012.
In December 2015, when the Committee decided to begin raising the target range for the federal funds rate from nearly zero–the first change in seven years–it indicated in its postmeeting statement that the timing and size of future adjustments in the policy target range would depend on “realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.”
As the economy heals, the Fed is worried about long-term interest rates
- Fed expected to keep interest rates steady at near zero
- First quarterly economic projections for 2020 on tap
- Investors look for interest rate guidance, stimulus update
- Yield Curve Control may be the next step
Today, as expected, the Federal Open Market Committee (FOMC) left interest rates unchanged and implied it would keep them there into 2022, as the economy tries to recover from the recession brought on by the coronavirus pandemic.
In a statement1, the FOMC said, “The coronavirus outbreak is causing tremendous human and economic hardship across the United States and around the world. The virus and the measures taken to protect public health have induced sharp declines in economic activity and a surge in job losses. Weaker demand and significantly lower oil prices are holding down consumer price inflation.”
The Fed also projected that the economy will shrink 6.5% in 2020, as businesses have laid off tens of millions of workers and industrial and manufacturing activity ground to a halt. However, 2021 is expected to show a 5% gain followed by 3.5% in 2022.
The Fed also pledged to continue its numerous monetary policy procedures aimed at injecting financial liquidity into the banking industry, small and medium sized businesses, government securities and corporate bonds.
Yield Curve Control (YCC)
There’s been increasing speculation that the central bank will use yield-curve control or interest rate caps for the first time since the 1940s to clampdown on rising Treasury security rates/yields and keep borrowing costs low for businesses and consumers. 54% of economists surveyed by Bloomberg believe this tactic will be on the table in September, but we may hear hints about it today. Federal Reserve Bank of New York President John Williams said in March policy makers are “thinking very hard” about YCC.
With quantitative easing, the bank promises to buy large quantities of bonds, but with Yield Curve Control (YCC) it focuses on the price of bonds to flatten the yield curve. With YCC, the Fed would set a target rate for a bond with specific maturity and vow to buy as much as necessary to keep the rate there.
“Interest rate pegs theoretically should affect financial conditions and the economy in many of the same ways as traditional monetary policy: lower interest rates on Treasury securities would feed through to lower interest rates on mortgages, car loans, and corporate debt, as well as higher stock prices and a cheaper dollar,” wrote Brookings economists. “If investors believe the Fed will stick to the peg, the Fed could achieve lower interest rates without significantly expanding its balance sheet.
In English: The fed buys bonds which put cash into the financial system. With more liquidity (cash) in the system and lower interest rates, the hope it to stimulate the economy without causing inflation.
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R. LaMont W.