Yield curve control (“YCC”), also sometimes called interest rate pegs, is where bond yields are set by the central bank.
Advocates of yield curve control, also called YCC, argue that, as short-term interest rates approach zero, keeping longer-term rates down may become an increasingly more effective policy alternative for stimulating the economy. Also, this approach could help prevent a recession or lessen the impact of a downturn. Richard Clarida and Lael Brainard, current members of the Board of Governors at the Fed, as well as former Fed chairs Ben Bernanke and Janet Yellen have said that the Fed should consider using yield curve control. Jerome Powell, the current Fed chair, also has said that he is potentially open to this policy option.
Let’s use iPhones as an example.
Apple creates a new iPhone with eight cameras.
But that’s not all…
The iPhone pays you $10 each year. For two years straight.
The price for this iPhone is $1,000.
So you buy it for $1,000 and every year for the next two years, it pays you $10.
The iPhone provides a 1% yield.
$1000 divided by $10 = 0.01 (or 1%).
Let’s say that the Fed wanted the price of the latest iPhone pegged at $1,000. More specifically, they want the YIELD pegged at 1%.
This means that the price of the iPhone must be pegged at $1,000.
But people who own them, hate them.
Their selfies look horrendous and want to get rid of their iPhones.
There’s now too much supply and not enough demand for the iPhone.
The sellers can’t find any buyers at $1,000 so they lower their price and offer $800.
But if it’s sold at $800, the yield goes up.
It’s now 1.25%.
$800 divided by $10 = 0.125 (or 1.25%).
The Fed doesn’t not like this at all! It wants the yield at 1%!
So the Fed steps in and buys up all the iPhones until enough supply is removed, that the price returns to $1,000.
This is YCC
Replace the iPhone with a 2-year bond with a 1% yield and now you’re back to the real world.