BIS: Long term interest rates – the neglected tool in the monetary policy toolbox
From Bond Vigilantes:
I was recently fortunate enough to see a presentation by Phillip
Turner from the Bank for International Settlements (BIS) on a paper he
published earlier this year. ‘Benign neglect of the long term interest rate’
is a highly informative and interesting piece. In it he argues that
after decades of the market determining long term interest rates the
“large scale purchases of government bonds have made the long term
interest rate key in the monetary policy debate”, and that a policy
framework should be implemented around long term rates.
The use of central bank balance sheets isn’t as novel a concept as
one might think when they hear (as I did repeatedly over 4 days of
conferences and seminars in conjunction with the IMF/world bank annual
meetings) QE described as unconventional monetary policy. In fact Keynes
argued that central banks should stand ready to buy and sell government
bonds as a means of affecting the price of money (the interest rate)
from as early as the 1930s. Furthermore, the Thatcher government engaged
in “quantitative tightening” as recently as the early 1980s by issuing
more long dated gilts than were required to finance government spending.
The rationale was that issuing more gilts would drain liquidity,
curtail broad money growth and slow inflation more effectively than just
increasing the Bank Rate.
Setting policy for longer term interest rates may be new territory
for today’s generation of policy makers however it shouldn’t be for
some. It’s often forgotten that the Fed actually has a triple, not dual
mandate. Along with maximising employment and promoting stable prices
they are also charged with providing moderate long term interest rates....MORE
...The inherent irony of lowering long term rates to stimulate the
economy is that it reduces the incentives for banks to perform their
socially useful function of maturity transformation – borrowing short
and lending long. The lower long term interest rates the less of an
incentive banks have to lend further out along the yield curve. The
graph below shows that the term premium in the US 10yr has been negative
for a large part of this decade....
