Guys, maybe I’m getting something wrong but there seems to be some discrepancies in the curriculum.
Reading 17 stays that steep yield curve is the effect of loose both monetary and fiscal policies and predicts an expansion in the economy. In contrast, inverted yield curve forecasts recession.
However, reading 33 states that steep yield curve is a sign of recession.
One explanation that comes to my mind is that generally government and central banks exibit serious lags in their activities and by the time they loosen their polices the economy may be entering a recession and a steep curve predicts further slowdown. On the other hand, high long term rates (or expected short term rates in the future) contradict this view and predict economic expansion.
Can someone clear this up? How exactly each shape of the yield cuve bodes for the economy?
It depends on what theory explains the shape of the yield curve. Pure expectations? Liquidity preference? Preferred habitat?
Even if we agree on pure expectations theory, we still have to decide why future interest rates will rise sharply (steep, normal yield curve) or fall (inverted yield curve). Will higher future interest rates push the economy into recession? Or will they be higher because the economy is expected to be expanding, so we anticipate restrictive monetary policy to try to slow it down? Will lower future interest rates push the economy into expansion? Or will they be lower because the economy is expected to be contracting, so we anticipate expansionary monetary policy to try to stabilize it?
Steep, like Beauty… is in the eye of the beholder… if it’s blatantly steep than it’s bubble territory. If you think of it like individual stocks or hot sectors, it’s the same.
steep yield curve can be interpreted as the economy is going into an expansion or the economy is currently experiencing a recession. So you will interpret the meaning based on the context given.