Series 3: 6.1.6.3. Supply: Yield Curve Analysis

6.1.6.3. Supply: Yield Curve Analysis

Another indicator of monetary policy and of the threat of inflation in the economy is the yield curve. The Federal Reserve’s manipulation of the federal funds rate is the principal driver of changes in the shape of the yield curve. A steep yield curve indicates a loose monetary policy and expectations of a growing economy and rising inflation. When the yield curve steepens, interest rates generally are expected to decline and the difference between short-term and long-term rates to widen. A flat yield curve indicates a tightening policy and higher short-term rates. Transitions in the yield curve tend to anticipate future changes in Treasury bond yields.

When the Fed tightens monetary policy by raising the federal funds rate, other short-term interest rates generally follow. Recall that an interest rate is composed of a risk-free rate, a risk premium, and inflation. Uncertainty over future inflation is of little importance for short-term in