Negative interest rates and inverted yield curves: an interpretation based on Liquidity Preference Theory

Abstract

Unusual interest rate behavior has become increasingly frequent in developed economies. Even though intuitively unlikely, government bond yields in negative territory are found in most European countries, and inverted yield curves for Treasury bonds in the United States occurred during some months. This paper presents the influence of conventional and non-conventional monetary policy instruments over the previously mentioned phenomena, and an interpretation based on the Liquidity Preference Theory proposed by Keynes. This interpretation explains, based on agents’ behavior, why public and private asset purchase programs, yield curve control and communication based on forward guidance used by central banks could persist and influence financial markets. This situation has enabled the occurrence of atypical phenomena regarding interest rates.

Keywords:
Negative interest rates; Yield curve; Keynesian Theory; Liquidity Preference