Understanding Economic Equilibrium

CHAPTER 33

The Yield Curve: What Is It Saying?

The yield curve is one of the most telling and referenced of all economic indicators. It is important because it represents the collective judgment of all participants, investors, and borrowers in financial markets everywhere.

At the turn of the twentieth century, American economist Irving Fisher published an “equation” that is still used to understand nominal and real interest rate behavior. He proposed that nominal interest rates can be decomposed into two factors: one is a real return on investment and the other, expected inflation. The Fisher equation declares that the real rate of return on a loan should be the nominal interest rate plus expected inflation. The lender requires some real return ...