The shape of the yield curve is frequently cited as a predictor of economic growth and as an indicator of where the economy is in the business cycle.
The yield curve demonstrates the relationship between interest rates and the maturity of debt securities. The curve is sensitive to government actions as well as current and expected economic conditions.
Fiscal and monetary policies may reinforce or conflict with each other. If the policies reinforce each other, the implications for the economy are clear. In all cases, there are likely implications for the yield curve:
- If both policies are stimulative, the yield curve is steep and the economy is likely to grow.
- If both policies are restrictive, the yield curve is inverted and the economy is likely to contract.
- If monetary policy is restrictive and fiscal policy is stimulative, the yield curve is flat and the implications for the economy are less clear.
- If monetary policy is stimulative and fiscal policy is restrictive, the yield curve is moderately steep and the implications for the economy are less clear.
In terms of the business cycle, the yield curve is typically:
- Steep at the bottom of the cycle.
- As the cycle moves toward expansion, the curve tends to flatten.
- At the top of the cycle, the yield curve will likely be flat to inverted.
- During contraction, the curve will begin to re-steepen.