Econ 100B: The Inverted Yield Curve

While talking about the inverted yield curve, I over-simplified the explanation (thanks, Gabe) of what causes it. While it does have to do with supply and demand, the yields are not related exactly in the way you might think. We will get back to where I over-simplified, and why, when we get to talking about the IS-LM curves.

In the meantime, I’ve posted the first handout for the semester. It’s a post by Barry Ritholtz on the blog Seeking Alpha. It illustrates the arguments for and against the yield curve as a predictor for recession. Remember that it is not a technical article (which is why I thought you might like it) and some of the issues have more complexities than meet the eye. But on the whole, it is an enjoyable read and illustrates how economists can never agree on anything and still be right about everything (!).

Here’s an excerpt:

So is the Yield Curve still relevant? There is a dispute amongst economists to that effect. In addition to the aforementioned Mr. Laffer, several other notables have raised questions:

“Two researchers who focus on recession forecasting, Lakshman Achuthan and Anirvan Banerji of the Economic Cycle Research Institute, argue that the yield curve is overrated as a recession harbinger. They note that the yield curve failed to invert before recessions in the 1950s and early 1960s. They also point to the misleading signal sent in 1966-67, when a lengthy inversion didn’t precede a recession.”

We know that there were recessions that were not preceded by an inverted yield curve. But were there inverted yield curves that didn’t produce a recession?

“Those who think highly of the yield curve’s predictive power have history on their side. Seven times between 1965 and 2005, yields on the 10-year note have dropped below those on the three-month Treasury bill for an extended span. In six of those instances, the U.S. economy went into recession soon after.

Here’s a direct link to the article.

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