The Economic Impact of Yield Curve Compression: Evidence from Euro Area Forward Guidance and Unconventional Monetary Policy

This paper studies the effects of forward guidance and unconventional monetary policy on financial and macro-economic variables using euro area data. I decompose intra-daily variation in response to communication by the ECB Governing Council using sign-restrictions, with the key identifying assumption being whether expansionary communication shocks steepen the yield curve (a forward guidance shock) or flatten it (a spread compression shock). Central bank “information shocks” are extracted via an additional restriction on equities. I employ recently developed non-parametric estimation methods to estimate a medium-scale time-varying parameter SVAR model with high-frequency identification, allowing consideration of multiple transmission channels simultaneously. Expansionary spread compression shocks markedly reduce volatility and persistently lower spreads, and affect activity and prices in line with theory. Spread compression surprises affect macro-economic variables in a manner comparable to forward guidance surprises. The effects of both forward guidance and yield curve compression surprises on inflation increased in the post-European sovereign debt crisis period, as did their effect on unemployment.