Question

Recently, during the coronavirus pandemic, the Federal Reserve began exploring new monetary policy tools, mainly the idea of yield curve control. Explain how... 1) traditional monetary policy affects the yield curve 2) How quantitative easing policies differ? and 3) How yield curve control differs from QE.

Answer 1

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Question:

Answer:

Traditional Monetary Policy:

Traditional monetary policy is policy that is adopted by the central bank to manage the money supply and interest rate. There are three main tools of traditional monetary policy: discount rate, buying and selling of government securities and reserve requirement. When central want to increase the money supply and decrease interest rate then its buying government securities from open market and vice versa. When central want to increase the money supply and decrease interest rate then its decrease the discount rate and reserve requirement.

Quantity Easing(QE):

It is more wider concept than the traditional monetary policy.In quantity easing the central bank buy long term treasuries, private securities, securities in a particular area of market as per the demand or situation of the economy. The objective of QE is to increase the money supply and decrease yield in the long term. Here, central bank pushing the economy through increasing money supply and decreasing long term interest rate/yield. This policy is follow by the central bank during the recession when, interest rate at very low level or zero and the economy needs more liquidity or money to boost the economy. This very popular in the USA and Fed has recently used QE during the 2008-09 recession and COVID-19 recession.

So, traditional monetary policy is use for the managing the short term liquidity crisis in financial system and affecting interest rate in short in short run. So, the objective of traditional monetary policy is short-term oriented. Other side the objective of QE is long term. Here, central bank pushing the economy through increasing money supply and decreasing long term interest rate/yield. This policy is follow by the central bank during the recession when, interest rate at very low level or zero.

Yield Curve:

Its show the graphical representation of relationship between yield/interest rate and maturity. Yield is a realized annual profit by the bond holders and it is flexible by nature.

Yield = Coupon amount/Bond price.

It means when bond price increase yield decrease and vice-versa. Other side the relationship between bond price and interest rate is opposite. It means both move together in opposite direction. When interest rate increases bond price decreased and vice-versa because of demand of bond.

How traditional monetary policy affects the yield curve?

So, traditional monetary policy is use for the managing the short term liquidity crisis in financial system and affecting interest rate in short in short run. So, when central bank buy government securities though OMO then its increase the demand of bond that increased the price of bond and decreased yield. So, short-term yield is higher than long term yield. So, yield curve slop is downward (downward slope yield curve)

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How quantitative easing policies differ?

It is more wide concept than traditional monetary policy.In quantity easing the central bank buy long term treasuries, private securities, securities in a particular area of market which as per the demand or situation of the economy. The objective of QE is to increase the money supply and decrease the yield in long term. The objective of QE is long term. Here, central bank pushing the economy through increasing money supply and decreasing long term interest rate/yield. This policy is follow by the central bank during the recession when, interest rate at very low level or zero.

So, in case of QE yield will decrease in the long term that will affect the long term yield curve. Other side though the QE policy the central bank buys securities in bulk or huge quantity that will affect the yield curve than traditional monetary policy. So, yield curve slop is downward (downward slope yield curve) and slope will more greater.

How yield curve control differs from QE?

Yield curve control means controlling and managing the long-term interest rate through buying and selling of securities. The central bank to this activity(yield curve control) by QE. In quantity easing the central bank buy long term treasuries, private securities, securities in a particular area of market which as per the demand or situation of the economy. The objective of QE is to increase the money supply and decrease the yield in long term. Here, central bank pushing the economy through increasing money supply and decreasing long term interest rate/yield. This policy is follow by the central bank during the recession when, interest rate at very low level or zero.The Fed commits to keep bond yields at a pre-determined level or control yield curve, by buying as many bonds as needed whenever necessary to bring yields down to their target and vice-versa.

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