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Question about the yield curve

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C posted on Thu, Jun 16 2011 7:28 PM

 

I’ve just read an article from Frank Shostak “What’s with the yield curve” http://mises.org/daily/382.

Now in business school i was taught over and over again that the reason the yield curve slopes upwards is because liquidity preference and the risk associated with longer term investments as Frank mentions in the article.

However, he suggests that theory is incorrect and in equilibrium the yield curve should be flat and cites Mises and Rothbard on this. The idea is that a lower interest rate at one term will create an arbitrage opportunity which would lead to the same interest rate at each term and that central bank intervention in short term rates creates the upward sloping yield curve. I’ve only done a quick search so far and haven’t found anything yet from Mises or Rothbard on this.

But does this really make sense? Would you lock your money up in a 30 year bond if it paid the same rate as a 1 year bond? Why would anyone ever invest in the long term if this was the case? I certainly wouldn’t.

And the liquidity preference theory seems to make sense to me…I currently have about $5,000 in a savings account. Now depending on what happens in the economy, I might need access to that money in a hurry. I would like to earn a higher interest rate than I currently earn, and have considered a 2 yr CD, but the 1.6% rate I was being offered wasn’t enough to get me to give up liquidity. I would be willing to invest in the CD but only if the rate was higher. Now isn’t that an example of liquidity preference?

Can anyone offer their thoughts on this?  

  At least he wasn't a Keynesian!

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Top 500 Contributor
157 Posts
Points 3,880
C replied on Thu, Jun 16 2011 7:43 PM

Found another article by Shostak where he says the "risk free" yield curve would be flat.  That once factoring in risk it would slope upwards slightly.  This makes more sense.  

  At least he wasn't a Keynesian!

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