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Inverted yield curve

An inverted yield curve is when short-term interest rates are higher than long-term interest rates.

Expanded Definition

An inverted yield curve is a classical indicator of recession.

The Federal Reserve Bank pushes up short term interest rates as a means to fight inflation. Long term interest rates respond more to market forces and change slowly. Hence, the Fed action tends to cause the yield curve to flatten or to invert. Therefore, the inverted yield curve is more an indicator of the Feds desire to curb inflation than it is an indicator of recession.

However, traditionally some believed the Fed needed to produce periodic recessions to purge weaker businesses from the system. There is a history of repeated recessions casued by Fed action in the record. In more recent times, the Fed has learned to curb inflation by less drastic actions, slowing down the economy with producing a formal recession. An inverted yield curve may no longer be a reliable indicator of recession.

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