Macroeconomics Write-Up

BA 6039 Macroeconomics

Summer 2015

Q1: Based on Mishkin (ch. 6), what does today’s yield curve (can be found in WSJ, usually p. C4) portend for the U.S. economy in 2015? In some ways this is a loaded/trick question.

Reliance on a daily tracking measure to forecast longer term outcomes is indeed tricky, particularly in an environment with new monetary policy tools at play, wavering consumer and firm confidence, stumped growth, political uncertainties, and talk of coming bubbles in asset markets. The yield curve, at the time of this writing, is upward sloping, indicating inflationary expectations of long-term rates to exceed current rates. This is generally seen as “good” news indicative of increasing confidence in the U.S.’s economic horizon. The yield curve’s shape and slope varies from the same time one year ago, and yields on individual Treasury instruments show greater variability (not unlike a mountain range) when examined across longer spans of time. The cross-sectional data point of the yield curve represents one point in time – today – and can readily change as other economic variables and expectations change. For now, based only on the yield curve, the outlook for 2015 is a positive one, as increasing rates are associated with a positive economic outlook. However, to hazard a guess about the health of the U.S. economy for the remainder of the year based on a single point-in-time barometer demands some caution.

Mishkin notes that yield curves are almost always upward sloping, and when short-term interest rates are low (and, with ZIRP, they are presently), yield curves are more likely to have an upward slope. These observations dampen exclusive reliance on an upward slope to portend economic strength in 2015. More so than expectations theory or market segmentation theory alone, Mishkin prefers liquidity premium theory to understand the term structure of interest rates, based on the assumption that risk-averse investors require a positive...