Question

Answer the following:

We discussed changes in the yield curve that result from changes in the term premium, expectations of future interest rates, and monetary policy. In the table below, state whether each situation is related to the term premium (TP), expectations of interest rates, or monetary policy; whether you expect the given situation to result in a change to short-term or long-term yields; and whether it will make the yield curve steeper (more normal) or flatter (flat or inverted):

Situation	TP, Expectations, or Policy?	ST or LT Yields?	Steeper or Flatter?
Interest rates are expected to decrease due to strong economic recovery.
The Federal Reserve pursues a higher target of the federal funds rate.
Perceived long-term risk increases as global financial markets become more stable.
Interest rates are expected to increase due to weakening economic conditions.
The Federal Reserve pursues a lower target of the federal funds rate.
Perceived long-term risk decreases as global financial markets become more volatile.

Answer 1

	TP, Expectations, Policy	ST or LT yields	Steeper or Flatter
Interest rates are expected to decrease due to strong economic recovery.	Expectations	LT	Flatter
The Federal Reserve pursues a higher target of the federal funds rate.	Policy	ST	Steeper
Perceived long-term risk increases as global financial markets become more stable.	Term premium	LT	Steeper
Interest rates are expected to increase due to weakening economic conditions.	Expectations	LT	Steeper
The Federal Reserve pursues a lower target of the federal funds rate.	Policy	ST	Flatter
Perceived long-term risk decreases as global financial markets become more volatile.	Term premium	LT	Flatter