"The impact of the maturity of US government debt on forward rates and the term premium: New results from old data"
From VoxEU:
The impact of the stock and maturity of government debt on longer-term
bond yields matters for monetary policy. This column assesses the
magnitude and relative importance of overall bond supply and maturity
effects on longer-term US Treasury interest rates using data from 1976
to 2008. Both factors have a significant impact on both forwards and
term premia, but maturity of public debt appears to matter more. The
results have implications for exit from unconventional policies, and
also for the links between monetary and fiscal policy and debt
management.
Revisiting the supply effect
The question of the impact of
the stock and maturity of net government debt on longer-term US Treasury
yields, and the potential implications for central bank balance sheet
policies, matters for monetary policy. For Keynes, Tobin, and Milton
Friedman, decisions about the maturity of government debt issuance had
major implications for the term structure of interest rates (Turner
2011).1
But earlier empirical studies, arguably starting with Modigliani and
Sutch (1967), seemed to find limited support for supply effects, with
Ben Friedman ([1981] 1992) a notable exception. In any event, the rise
of New Classical Macroeconomics and the mainstream New Keynesian model
led many economists to ignore portfolio balance effects. Under this new
orthodoxy, that inhabited a world of (near-)perfectly elastic demand for
government debt, the relative supply of short- and long-dated
government bonds had little effect on longer-term interest rates. The
yield curve was in turn determined by the current level and expected
path of the policy rate. For Ricardian-type reasons, the method of
financing a given level of government expenditure would have no impact
on the level of consumption, and hence on the path of interest rates.
And so the proper focus of monetary policy became solely the assessment
of the correct level for the short-term policy rate.
But in trying to assess the prospective and actual impact of large-scale
central bank purchases on government bonds, a number of recent studies
have attempted to estimate the impact of debt issuance on interest
rates. Kuttner (2006) freely admits that his estimates, on quarterly
data from 1964–2004, may be ‘too strong’, as he finds that a 2
percentage-point increase in central bank holdings of debt reduces the
term premium by around 200 basis points, but they are certainly
indicative of the results emerging from several subsequent studies....MORE
HT:
Economist's View
