Networking the Yield Curve: Implications for Monetary Policy

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How do different monetary policies affect the yield curve and interact with each other? To answer this question, we introduce a novel network model for interest rate surprises of different maturities. We establish model properties and identification through simulation studies. Using the model, we implement different monetary policy scenarios: modelling simultaneous interventions in different segments of the bond market while varying the strength of forward guidance.

We find that the overall effect on the yield curve depends on the size of monetary policy shocks, the targeted maturities and the strength of forward guidance. Therefore, which maturity a central bank should target and by how much may depend on policy objectives. For example, targeting medium-term bond yields may be the preferable approach to move yields of all maturities in the same direction. If the intention of a central bank is to (un)flatten the yield curve or affect a particular segment of the yield curve more than others, then a few alternative policy combinations might achieve this.

Our study highlights the importance of the spillover structure for policy-making. It also demonstrates that careful consideration of complementarities of policy tools and their potential amplifications are important for policy design.