How far can we use the shape of the yield curve to derive expectations Research Paper

How far can we use the shape of the yield curve to derive expectations about outlook for an economy - Research Paper Example The slope of the yield curve is considered as one of the important indicators as it shows the difference between the long and short run interest rates in the economy. The critical difference between the two interest rates therefore defines how the future outlook of the economy can change. The overall macroeconomic significance of the slope of the yield curve is based upon the overall monetary response to the shocks received by the economy over the period of time. Economists therefore use the statistical relationship between the slope of the yield curve and economic growth and observe as to where the yield curve is actually pointing. This approach also requires taking different parameters before the overall state of economy can be reliably estimated based on the interest rate spreads. (F. Cwik, 2005) The slop of yield curve can be one of the most important indicators for assessing the economic performance of a country and make future expectations. Yield curve slope can provide essential information about the economic growth, inflation and recessions. Yield curve showing the difference between the 10 years treasury bonds and the federal fund rate therefore serves as one of the key economic indicators about the overall state of the economy. It has also been argued that if consumers expect to have a recession in future, they may reduce their consumption in order to increase their savings for future consumption. Thus the short term interest rates may go up as a result of this and resultantly the gap between the short and long term interest rates may narrow. In such a situation therefore the shape of the yield curve therefore can provide the estimate about the economy. (Federal Reserve Bank of Cleveland , 2011) Yield curve provided two important forecasting insights into the overall affairs of the economy i.e. the growth as well as the recession. First, it also can help