Bad ideas in economics never die; they just wait a few months, then resurface, once again touted as wisdom.
This morning I read the FT telling us that bond markets are signaling worries about growth, as indeed they are; but I also see Caroline Baum telling us not to worry, because the yield curve is upward-sloping.
Sigh.
I?ve written about this repeatedly. Just to reprint the argument:
The reason for the historical relationship between the slope of the yield curve and the economy?s performance is that the long-term rate is, in effect, a prediction of future short-term rates. If investors expect the economy to contract, they also expect the Fed to cut rates, which tends to make the yield curve negatively sloped. If they expect the economy to expand, they expect the Fed to raise rates, making the yield curve positively sloped.
But here?s the thing: the Fed can?t cut rates from here, because they?re already zero. It can, however, raise rates. So the long-term rate has to be above the short-term rate, because under current conditions it?s like an option price: short rates might move up, but they can?t go down.
I?m getting tired of this.
Source: http://krugman.blogs.nytimes.com/2011/05/30/the-unkillable-yield-curve-fallacy-wonkish/
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