What Do Central Banks Do?

by Michael J. Howell11. March 2013 12:11

Prompted by yet another claim, this time by the great house of Goldman that Central Bank QE push up bond prices and push down yields by circa 100-125bp, it is worth looking at the facts and the theory. QE1, QE2 and now QE3 have seen generic 10 year yields rise. The ending of QE1 and QE2 saw 10 year yields fall. It is really that simple. If the 10 year bond represents the risk free asset for many long-term funds, then Central Bank balance sheet expansion will likely lower the risk premia on other risky assets and raise the risk premia on bonds. In short, the yield curve will steepen after each QE: it did and it is again now. Why the fuss? Surely, this is exactly what policy-makers want to do? Falling long-term yields would signal their failure not their success!

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