Economic Letter: The Economic Impact of Yield Curve Compression

• Paper examines the effects of conventional and unconventional monetary policies on financial and macroeconomic variables using euro area data.
• Both conventional and unconventional expansionary monetary policies raise the level of industrial production, reduce unemployment, and raise the price level.
• However, the paper shows that the effects of unconventional monetary policy shocks are larger in magnitude for all three variables, and the paper also provides up-to-date conditional forecasts of the euro area economy under different policy actions by the ECB.

An Economic Letter (PDF 1.21MB) written by Central Bank of Ireland economist Robert Goodhead published today examines the effects of conventional and unconventional monetary policies on financial and macroeconomic variables using euro area data. Conventional and unconventional monetary policies are separated in a general way through their effects on the yield curve.

During the period following the 2007-08 global financial crisis, the ECB and many other developed economy central banks turned to unconventional monetary policies to achieve their macroeconomic stabilisation goals. These central banks faced the problem of a lower bound on interest rates, meaning they could not cut their policy rates to low enough levels to respond effectively to negative developments in the economic cycle. In response to these constraints, central banks have turned to unconventional monetary policies; the Asset Purchase Programme (APP) of the ECB being an example.

With respect to the macro-economic variables, the research finds that both conventional and unconventional monetary policy shocks raise the level of industrial production, reduce the unemployment rate, and raise the price level in ways consistent with theory, though the responses for the activity variables to conventional monetary policy are not significant.

However, the effects of unconventional monetary policy shocks are larger in magnitude for all three variables. The paper also finds that unconventional monetary policy shocks have an effect on the price level with a greater delay relative to conventional monetary policy shocks, and peak at around two years after the shock.