Yield curve relating to expansive / restrictive fiscal / monetary policies.

CFA Level III
#1

in Book 3 of Schweser page 42, there’s a question asking the likely scenario of restrictive and expansive policies. Basically item set tells you that the yield curve is flat; ask you to determine the policies. If I remember correctly in the book 2; Schweser says restrictive fiscal policy together + expansive monetary policy => slightly downward sloping yield curve. While the restive monetary policy + expansive fiscal policy => more or less flat yield curve? So shouldn’t the flat yield curve imply the latter combination: expansive fiscal + restrictive monetary?

#2

“So shouldn’t the flat yield curve imply the latter combination: expansive fiscal + restrictive monetary?” Yes this is true. “restrictive fiscal policy together + expansive monetary policy => slightly downward sloping yield curve.” The above has to be slightly upward sloping yield curve , if i am right.

#3

I think I got this reversed… I mean to say: Basically item set tells you that the yield curve is flat; ask you to determine the policies. If I remember correctly in the book 2; Schweser says restrictive fiscal policy together + expansive monetary policy => more or less flat yield curve. While the restrictive monetary policy + expansive fiscal policy => slightly upward trending? So shouldn’t the flat yield curve imply the former combination: restrictive fiscal + expansive monetary? But Schweser answer says the opposite? I don’t have book 2 at hand and can’t verify this.

#4

The question boils down to which of the fiscal and monetary policy dominates?

#5

“So shouldn’t the flat yield curve imply the former combination: restrictive fiscal + expansive monetary?” No the above results in slightly upward sloping yield curve. The reason for this being …expansionary monitory policy implies the lowering of short term rates which pulls the short end down, leading to a slight upward slope. Hope this helps.

#6

“The question boils down to which of the fiscal and monetary policy dominates?” Monitory policy dominates over short term. Over long term both are very effective but fiscal more so than monitory policy because expansionary monitory policy quickly leads to inflation.

#7

Thanks. This is good stuff.

#8

So, should be any changes in the answers of MM Mock Exam question?

Do we consider flat yield curve as tight fiscal policy? (CFA Online Qbank says it is loose)…

Thanks to everyone!

#9

No. Flat = Restrictive monetary and Loose fiscal.

#10

But in the answers of the Mock tight fiscal = flat yield curve.

No changes were made on the MM’s site…