Question

How do changes to the federal funds rate affect the yield curve? What shape of the yield curve is a useful predictor of recessions?

Answer 1

of of the short-term interest rate be- 1 A yield curve is a line that plots yields Cinterest rates) bonds having equal credit quality but differing maturity dates. The slope of the yield curve gives an idea future interest rate changes & econ & economic activity. There are three types of yield shapes : ( up ward slopping curve) inverted downw ard sloping curre) e flat. If the fed to increase the funds rate, it supplies more short term in open market operations. The the supply short term the money in circulation borrowers give money give money to the fed. In this decrease in in the normal curre wants securities of increase in secunities restricts since tum , money supply D increases there is cause less money in circulation available borrowers. By increasing the

2 the very short AD ase curve to occuri but also the same time carry information of future recession supply of short-term Securities tem securities the fed is yanking up left end of the curre & the nearby term yields will Snap quickly increas in funds tends to flatten the curve because the Yield reflects nominal interest rates. Recessions are difficult predict, in part because they rarely because the factors that drive in to recession economy likely to differ episodes. As consequence factor that may drive recession may fare poorly in predicting tums. Using many explanatory variables limited ability has to': predict recession in the slope of the yield curve curre has proven promising parsimonious because a possibly variety of of downturns inversion of at can drive yield the a most accross a a one other down contrast indicator curve factors