What is the relationship between the yield curve and the economy?

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The yield curve is a curve that depicts several interest rates for several loan periods (1 year, 5 years, 15 years, 20 years, 30 years, etc.) for the same loan to a particular borrower. The yield curve is significant to the international economy because the yield curve indicates the economic position of each country and which currency will dominate the international economy when a government issues bonds.

The slope of the yield curve is a significant predictor of future economic conditions, where it be growth, recession, or inflation. A yield curve that has a positive correlation along the x and y axis indicates inflation. A yield curve that has an inverted shape indicates a recession. Furthermore, the yield curve directly impacts the business cycle of banks. An inverted yield curve results in banks paying more interest on short-term deposits than extending long-term lines of credit to borrowers. Banks are less likely to lend during these times due to a possible loss of profits. A positively correlated yield curve results in banks accumulating more profits from short-term deposits as well as issuing new long-term lines of credit to borrowers. This results in a credit bubble (asset bubble), which is where the profits are higher than the actual value.

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