Question

Suppose a new Congress and administration overrule the independence of the Federal Reserve System and force the Fed to greatly expand the money supply. What effect will this have?

A. On the level and slope of the yield curve immediately after the announcement?

B. On the level and slope of the yield curve that would exist two to three years in the future?

Answer 1

A.this will have the effect immediately after the announcement as the yield curve will become significantly steeper and it will become steeper because the short term interest rate would decrease.

this is attributed to the fact that the Federal Reserve deal mainly in the short-term sector and the curve would also Steepen because people will expect the inflation to increase making the long term interest rate rise

B. This will have the effect that if the government maintain the same policy then Expanded money supply will cause inflation rates to rise.

Increased inflation rate would lead to overall higher interest rates since inflation premium will rise on securities.