Short-term interest rate setting versus quantitative easing in the determination of the yield curve slope

We begin with an econometric analysis of the determination of long-term interest rates in the United States and the euro zone. It shows that they depend on expected inflation, the global savings rate, expected short-term interest rates and the stock of bonds held by the central bank. This shows that with the two monetary policy instruments (forward guidance on short-term interest rates and management of the size of the central bank balance sheet), central banks can determine the slope of the yield curve. For example, when monetary policy becomes less expansionary: The yield curve inverts if short-term interest rates increase and the size of the balance sheet is merely stabilise d instead of being reduced; The yield curve steepens if short-term interest rates remain low and the size of the balance sheet is reduced. The central banks probably prefer this second option, which spaces out over time the end of quantitative easing and short-term interest rate hikes. Today, this means that the sequence: Central bank balance sheet stabilisation → Balance sheet reduction → Increase in short-term interest rates, has become more likely than the sequence: Central bank balance sheet stabilisation → Increase in short-term interest rates → Balance sheet reduction.