Quantitative Easing (QE) vs Yield Curve Control (YCC): Japanese case study

During the period named “the lost decade”, Japan experienced long-lasting deflation. Despite various monetary policies being implemented including quantitative easing (QE) or negative interest rate policies (NIRP) aiming to stimulate aggregate demand, inflation rate remains below 2%. In September 2016, the Japanese central bank introduced the money experiment called Yield Curve Control (YCC). 

Yield curve control (YCC) is a type of monetary policy where a central bank sets a target for interest rates on specific maturities of government bonds, which involve buying and selling any amount that is necessary to maintain the target yields. Firstly, quantitative easing (QE) emphasises on the quantity of bonds purchased and thus lowers the interest rate indirectly - however, if the market still thinks that the purchases are not enough, yields can still rise. In contrast, YCC guarantees a ceiling or anchor for key maturities, which gives the market a stronger signal of future short rates (i.e. expectation) and makes investors less likely to sell bonds. In other words, the “announcement effect” and credibility boost in YCC cause a more profound change in portfolio behaviour, which makes it easier for the central bank to achieve its broader macroeconomic objectives. 

Secondly, quantitative easing gave the central bank large balance sheet growth regardless of whether the market needed that much support, since the quantity purchased is the main target of this policy. In YCC, the purchase volume is not fixed - thus the credible threat of unlimited buying deters investors from betting against the BoJ. Empirical evidence has shown that the BoJ’s purchase of Japanese government bonds per month actually fell compared to QE years, and the 10-year yield was successfully kept at 0%. In a simpler sense, yield curve control gives more “yield control per yen spent” compared to quantitative easing. 

As of 2016, the 0% yield goal was set, together with a narrow fluctuation range. Empirical evidence from the Bundesbank demonstrates that YCC contributed to approximately 1/3 of the total impact of Japan’s unconventional monetary measures, boosting real GDP and stimulating inflation rate. Additionally, further insights from BoJ’s internal research reveal that both stock effects (the central bank’s accumulation of bond holdings) and the YCC framework prevent upward pressure on long-term interest rates, particularly when yields approach the upper band of the target range. 

One of the main criticisms of yield curve control is market distortion. Normally, yields naturally rise if investors expect higher inflation in the future (i.e. they demand higher compensation), therefore the interest rate normally reflects risks. However, with YCC, yields cannot be pushed higher even if investors are worried about future inflation - therefore prices discovery decreases and no longer reflects market sentiment. Additionally, the fact that the Bank of Japan ended up holding more than half of the outstanding Japanese government bonds (JGBs), which means that there are fewer assets left for banks and investors to buy and sell on the market, thus causing trading volume to fall. In the cases of external shocks, there would not be enough willing buyers and sellers to absorb the shocks, thus causing prices to change more profoundly. 

Regarding the macroeconomic results of YCC, lower interest rates enable households and firms in the Japanese economy to borrow more, thus stimulating consumption, investment and subsequently aggregate demand. For most of the 2016 to 2021 period, inflation stayed around 2%, contributing to the depreciation of the yen and making Japanese exports more price-competitive on the international markets. According to the traditional framework of liquidity preference-money supply and the Phillips curve logic, cutting interest rates stimulates demand and inflation - which is supported by the outcome of Japan’s YCC. However, despite aggressive monetary stimulus, the inflation rate did not exceed 2% or even fell during certain periods. This persistence of low inflation regardless of extreme monetary easing may support an alternative viewpoint called the Neo-Fisherian argument - which suggests that low nominal interest rates actually reinforce low inflation expectations. Ultimately, up to 2023 when inflation rises above 2% due to higher imported energy prices (i.e. cost-push inflation), the BoJ announced the end of the YCC money experiment.