>SPECIAL REPORT (ECONOMIC RESEARCH)

Are the consequences for the yield curve very different according to whether excess liquidity leads to inflation or a rise in asset prices?

Global liquidity is extremely abundant. Until 2008 this was due to the rise in official reserves, since 2008 it has been due to very expansionary domestic monetary policies, and in the recent period is has been accounted for by both these causes.

We would like to look at the effects of the very abundant global liquidity on yield curves:

− if they brought back inflation (which will not be the case, but this is what many financial market participants believe), there would straight away be a rise in long term interest rates and yield-curve steepening;

− but if inflation cannot return, due to the situation of massive under-employment, and if there are asset price bubbles because of excess liquidity (emerging country equities, credit), it is not certain that yield curves will steepen less, because of the correlation between bond yields and returns on other available assets;

− the case of commodity prices is obviously somewhere in between.

This shows that, even though excess monetary creation no longer leads to inflation in prices of goods and services in contemporary economies, it can nevertheless lead to a rise in long-term interest rates.

1 - Excess liquidity, but disappearance of goods and services inflation, excluding commodities
Global liquidity is extraordinarily abundant.

− until early 2008 mainly owing to the accumulation of official reserves in Japan and in emerging and oil exporting countries;

− since the start of the crisis, due to the extremely expansionary monetary policies implemented in OECD countries;

− since the spring of 2009, there has again been accumulation of official reserves in emerging
countries, due to capital flows returning to these countries, which is causing a renewed appreciation in their exchange rates.

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