Who can explain why: Which of the following is consistent with a flat yield curve? A) Monetary policy is expansive and fiscal policy is expansive. B) Monetary policy is restrictive and fiscal policy is restrictive. C) Monetary policy is restrictive while fiscal policy is expansive. D) Monetary policy is expansive while fiscal policy is restrictive. Your answer: C was correct. Why does D not result in the same answer?
D will still produce a upward-sloping curve, however, not as sharp as A. According to CFAI and Schweser.
thanks WS but not quite what i’m looking for - i can memorize the answer but i am hoping to understand why D produces an upward sloping while C produces a flat…
think of it this way restrcitive monetary policy will affect lower portion of yield curve, raising it up and its effect will be quick (relativelly speaking), if the rate is increase is modest the yield curve will become relativelly flat, if the icrease is drastic (say 200 bps), it can make it inverted on the other hand restricitve fiscal policy takes much longer to be implemented, so its affect won’t be as quick, short term rates may rise but not by as much as compared to restrictive monetary policy, so the yiled curve can still be moderatelly steep
If we can cut a normal yield curve right down at its midpoint. The left-half would be the shortside (controlled by the Fed, monetary), the right-half would be the longside (controlled by the government policy, fiscal). For answer C So, when the government is expansive, the rightside of the yield curve is still upward sloping, however, if the fed is restrictive, the shortside rate will go up, when you combine this two piece together, it looks like the yield curve is flat. For answer D When Fed is expansive, the leftside of the yield curve is upward sloping, however, given the government policy is restrictive, the rightside of the yield curve is somewhat flat; so if you put these two piece together, the general shape is still upward sloping. It would be great if we have some visually aid, I hope this helps.
WS et all - helpful - i can visualize it now and it makes sense…word.
let me get this right: Expansive monetary policy implies decreasing interest rates and increasing money supply Restrictive monetary policy implies increasing interest rates and decreasing money supply Correct?
^Correct. I would add short-term in there.
WS - In your explanation for answer D, I am having a hard time visualizing an upward slope. It would seem as if the left side (monetary policy) would be downward sloping as rates decrease w/ expansive policy and the right side would be downward sloping as well to reflect a decrease in spending. Could you please explain? Thanks