Term premiums in the euro area are at historically low levels and this may lead to think that there is no room for further decline. From a theoretical and empirical point of view, this study analyzes the extent to which the resumption of net purchases of government bonds by the Eurosystem could exert a new downward pressure on term premiums and long-term interest rates in the euro area when the short rate is at the effective lower bound (ELB).
Theory suggests that, by extracting duration from the market, the central bank can reduce term premiums. However, at the ELB, duration is no longer sufficient to assess the impact of purchases. Empirically, we show that further purchases are less effective the more the shadow rate is below the ELB and the lower the volatility of long-term yields. Nevertheless, they are still effective. As the duration held by investors can be decreased, the analysis suggests that there is room to reduce yields.
