Most periods of flat or inverted yield curves occur

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Unformatted text preview: erences between the two ends of the interest rate spectrum. Most periods of flat or inverted yield curves occur when the Federal Reserve increases short-term rates, tightening monetary policy to control inflation. These higher rates curtail business growth because savers pull money out of long-term investments such as stocks and bonds and put it into lower-risk savings vehicles. When short-term rates are low, people switch money from liquid investments such as money market accounts into long-term investments, fueling economic growth. This proved true in 2001. An inverted yield curve from July 2000 to early January 2001 triggered the slowdown in economic activity. In January the Federal Reserve cut the federal funds rate (the rate on loan transactions between commercial banks) to stimulate the economy but wasn’t able to prevent the recession that began in March 2001. The Fed cut short- 269 In Practice term rates 10 more times in 2001— a record for cuts in one year—to bring the “fed funds” rate from 6.5 percent to 1.75 percent, the lowest level since 1961. Long-term U.S. Treasury securities outperformed shorter maturities as institutional and individual investors shifted their portfolios to longer maturities, betting that the curve would return to its more normal upward slope as the Federal Reserve rate cuts took effect. By December 2001 the spread between long-term and short-term Treasury securities was about 2.5 points. As the yield curve turned strongly positive, economists predicted a short recession with a strong recovery in 2002. Sources: Adapted from Peronet Despeignes, “Fed Cuts Rates by Quarter Point to 1.75%,” FT.com (December 11, 2001), downloaded from news.ft.com; Michael Sivy, “Ahead of the Curve,” Money (August 2001), p. 51; Michael Wallace, “The Fed Can’t Get Ahead of the Curve,” Business Week Online (November 5, 2001), downloaded from www.businessweek.com; Linda Wertheimer, “Analysis: Federal Reserve’s Latest Interest Rate Cut,...
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This document was uploaded on 01/19/2014.

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