when the fed ajusts the discount rate upwards, what happens to the T-bill rate? what happens to the term structure? why is it that when the yield curve is inverted, a recession is likely to follow?
Long term interest rates are countercyclical while short term rates are procyclical… In a recession the yield curve will be upward sloping… When the yield curve is inverted the long term rates are lower than short term … The interpretation of this yield curve … the central bank will have to reduce the rates in long run to stimulate the economy … which can only happen in a recession in the long run… so usually recession floows an inverted yield curve… Yield curve reflects the long term expectations about the economy…
…while medium term interest rates are popciclical. The effect of the Fed changing the discount rate on T-bill prices is sort-of an empirical question. There really shouldn’t be a direct connection between the Fed’s short-term lending rate to banks and the gov’ts short-term borrowing rate from everyone else. But of course they are connected because all short-term interest rates are connected. When the discount rate goes up, you should expect that T-bill rates do too. For the second question, if the yield curve is inverted it means that people are expecting a drop in the demand for money. Money demand is low during a recession. Whether or not that effect actually happens, I dunno.