Central Bank Policy Sets the Lower Bound on Bond Yields

15 Pages Posted: 24 Mar 2020

See all articles by Joseph Gagnon

Joseph Gagnon

Peterson Institute

Olivier Jeanne

Peterson Institute for International Economics

Date Written: 2020

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

JEL Classification: E43, E58, G12

Suggested Citation

Gagnon, Joseph and Jeanne, Olivier, Central Bank Policy Sets the Lower Bound on Bond Yields (2020). Peterson Institute for International Economics Working Paper No. 20-2, 2020, Available at SSRN: https://ssrn.com/abstract=3532003 or http://dx.doi.org/10.2139/ssrn.3532003

Joseph Gagnon (Contact Author)

Peterson Institute ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

HOME PAGE: http://www.piie.com

Olivier Jeanne

Peterson Institute for International Economics ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States
202-328-9000 (Phone)

HOME PAGE: http://www.piie.com/staff/author_bio.cfm?author_id=601

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