Question

What is the yield curve? Why is the yield curve considered a leading economic indicator? Which of the following are congruent with a steepening, upward sloping yield curve? Why or why not?

Monetary policy and fiscal policy are expansive

Monetary policy is expensive while fiscal policy is restrictive

Monetary policy and fiscal policy are restrictive

Answer 1

Yield curve refers to a graph in which the yield is displayed against time. It is a line which plots the interest rates of securities which have different maturing dates. Upward sloping yield curve indicates that the yields are higher on longer term securities.

Monetary policy and fiscal policy are expansive

The monetary policy refers to the process by which the central bank controls the money supply in the economy. Expansive monetary policy increases total supply of money. This implies a fall in the short term interest rates and mobilizes the economy. In the long run this is expected to have a higher interest rate and hence the yield will be upward sloping. This is because higher yield is expected on long term securities since rates are likely to increase in future due to higher growth.

When fiscal policy is expansive the tax rates are lower and people have higher disposable income. So there is expectation of inflation in future. This causes the yields of long term securities to increase