Researchers from the Bank for International Settlements investigate how central bank balance sheet policies affect investor demand for government debt. As central banks embark on quantitative tightening (QT) to shrink their balance sheets, how different sectors will absorb government debt will largely depend on how sensitive their demand is to changes in the yields (or prices) of government bonds.
They studied compositional shifts in the investors that hold government debt in the euro area, Japan, the United Kingdom and the United States, and ask how different investor groups would respond under QT.
Findings show that a 1 percentage point increase in long-term yields leads to an 11% increase in the demand by non-central bank players for US Treasury securities. Based on estimates of the yield elasticity of different sectors, they infer the market-clearing yields under different quantitative tightening scenarios.
For example, all else constant, a hypothetical reduction in the central bank balance sheet of around $215 billion leads to an increase in long-term bond yields by 10 basis points in the United States. Their estimates are quantitatively close to those for the euro area and they are also in more or less the same ballpark as estimates of the impact of quantitative easing obtained via other methods.