Explaining The 'Yield Curve' Can the yield curve predict recession, or is it a dated model? Planet Money explains.
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Explaining The 'Yield Curve'

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Explaining The 'Yield Curve'

Explaining The 'Yield Curve'

Explaining The 'Yield Curve'

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Can the yield curve predict recession, or is it a dated model? Planet Money explains.

NOEL KING, HOST:

In economics, there's this thing that people think can help predict whether or not a recession is coming. It's called the yield curve. But some experts now think it may not be the predictor it once was. Cardiff Garcia is the co-host of NPR's daily economics podcast The Indicator, and he's here to explain. Hey, Cardiff.

CARDIFF GARCIA, BYLINE: Hey, Noel.

KING: All right. So first off, right off the bat, what is the yield curve?

GARCIA: Starting with the basics, the yield curve shows the different interest rates paid by each of the different kinds of U.S. government debt or just treasuries, as they're normally called. So there is a three-month treasury, a two-year treasury, a 10-year treasury and so on. And they each pay a different interest rate. And when the economy is expected to do well, when times are good, the interest rates on those longer-term treasuries, like the 10-year, are higher than the interest rates on the shorter-term treasuries, like the two-year. And so we say that, typically, the yield curve is sloping up.

KING: OK. So sloping up is a good thing. What does the yield curve look like right now today?

GARCIA: Well, it is flattening. And that's what happens when people start to worry a little bit about what the economy's going to do. And flattening yield curve - what that means is that the difference between those short-term interest rates and those higher longer-term interest rates has started to shrink. And, sometimes, the yield curve even inverts and starts to slope down. And every single time the yield curve has inverted since 1970, the U.S. economy has fallen into a recession within about a year.

KING: Wow.

GARCIA: That's why right now, so many people are paying attention to the yield curve because it is flattening, and it looks like it might invert. And this extends even to policymakers on the Federal Reserve, who are right now actively discussing amongst themselves whether they should pay attention to the yield curve and whether they might even consider altering the trajectory of their policies based on what it looks like right now.

KING: OK. So there's a lot of dense information there. But I've been reading that not all economists think that the yield curve is as good a predictor of coming troubles as it once was. Why is that?

GARCIA: Yeah. So the thinking is that it's possible that because the Federal Reserve itself is now such a huge buyer of treasuries as part of its attempts to stimulate the economy in the time since the recession of 2008 and 2009 that the yield curve itself is now distorted. And so the signals that it sends are no longer as useful as it used to be. That, again, is the thinking. There's no clear answer on it.

KING: So it may not be the best predictor. Let me ask you. Is there a good predictor of whether or not we're headed into a recession? Is there a better predictor of whether or not we're headed into a recession?

GARCIA: Nothing with nearly as good a track record as the yield curve, at least not that economists have, like, widely identified. And that, I think, is one reason to continue paying attention, even if it does prove to be the case that the yield curve is different this time. Nothing else has been as reliable. And, Noel, the other thing to keep in mind is that we've had these conversations about the yield curve before...

KING: Yeah.

GARCIA: ...In the past. When it has inverted, economists and the Fed have debated whether or not it was still as good a predictor. And it ended up proving to still be every bit the predictor that it had been in prior decades. And so I think it would be a bit of a mistake to suddenly turn away from it now.

KING: All right. So everyone keep your eyes on the yield curve.

GARCIA: You bet.

KING: Cardiff Garcia is co-host of NPR's daily economics podcast The Indicator. Cardiff, thank you so much.

KING: Thanks, Noel.

(SOUNDBITE OF BLAZO'S "NATURAL GREEN")

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