Forward Guidance in the Yield Curve: Short Rates Versus Bond Supply

49 Pages Posted: 21 Dec 2015 Last revised: 6 Dec 2024

See all articles by Robin M. Greenwood

Robin M. Greenwood

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)

Samuel Gregory Hanson

Harvard University - Business School (HBS)

Dimitri Vayanos

London School of Economics; Center for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: December 2015

Abstract

We present a model of the yield curve in which the central bank can provide market participants with forward guidance on both future short rates and on future Quantitative Easing (QE) operations, which affect bond supply. Forward guidance on short rates works through the expectations hypothesis, while forward guidance on QE works through expected future bond risk premia. If a QE operation is expected to be undone in the near term, then its announcement will have a hump-shaped effect on the yield and forward-rate curves; otherwise the effect may be increasing with maturity. Humps associated to QE announcements typically occur at maturities longer than those associated to short-rate announcements, even when the effects of the former are expected to last over a shorter horizon. We use our model to re-examine the empirical evidence on QE announcements in the US.

Suggested Citation

Greenwood, Robin M. and Hanson, Samuel Gregory and Vayanos, Dimitri, Forward Guidance in the Yield Curve: Short Rates Versus Bond Supply (December 2015). NBER Working Paper No. w21750, Available at SSRN: https://ssrn.com/abstract=2706309

Robin M. Greenwood (Contact Author)

Harvard Business School - Finance Unit ( email )

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Samuel Gregory Hanson

Harvard University - Business School (HBS) ( email )

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Dimitri Vayanos

London School of Economics ( email )

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Center for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER)

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United States

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