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Yield curves and recessions

Let me get back to my discussion of the neo-Wicksellian macro model. One important feature of the model, is that it suggests that the central bank controls the rate of interest, and it should try to flatten the yield curve. That is, the bank rate (short run) should adjust to the natural rate (long run). In many respects this is the general rule behind all conventional stories about central banking. The Taylor Rule or the New Keynesian ideas behind Clarida, Galí and Gertler are basically a variation of Wicksell's story.

One thing that is also important about Wicksell's rule is that if the yield curve is negatively sloped (the bank rate is higher than the natural rate) then a recession (deflationary forces) are to be expected. The graph below uses the Fed Funds for the bank rate and the 10 year Treasury bond rate for the natural rate. In between the gray lines the official NBER recessions are shown.
As it can be seen, after the red line (Fed Funds) moves above the blue line (Treasury bonds rate) a recession always follows. There are many problems with the Wicksellian model, not the least the assumption of a natural rate of interest, that was severely criticized by Keynes in the General Theory. But the empirical notion that an inverted yield curve forecasts a recession seems to survive any possible theoretical critique. More on the critique will be left for other posts.


  1. Hey Matias, two questions: one, where in the GT does keynes criticize the concept of the natural rate? Also, didn't the cambridge controversy also prove the invalidity of thr natural rate?

    Great blog, by the way. Congrats

  2. In chapter 17 of the GT he says:

    :In my Treatise on Money I defined what purported to be a unique rate of interest, which I called the natural rate of interest — namely, the rate of interest which, in the terminology of my Treatise, preserved equality between the rate of saving (as there defined) and the rate of investment. I believed this to be a development and clarification of Wicksell’s “natural rate of interest”, which was, according to him, the rate which would preserve the stability if some, not quite clearly specified, price-level.

    I had, however, overlooked the fact that in any given society there is, on this definition, a different natural rate of interest for each hypothetical level of employment. And, similarly, for every rate of interest there is a level of employment for which that rate is the “natural” rate, in the sense that the system will be in equilibrium with that rate of interest and that level of employment. Thus it was a mistake to speak of the natural rate of interest or to suggest that the above definition would yield a unique value for the rate of interest irrespective of the level of employment. I had not then understood that, in certain conditions, the system could be in equilibrium with less than full employment.

    I am now no longer of the opinion that the concept of a “natural” rate of interest, which previously seemed to me a most promising idea, has anything very useful or significant to contribute to our analysis. It is merely the rate of interest which will preserve the status quo; and, in general, we have no predominant interest in the status quo as such."

    Link here:

    Agreed on capital debates. Recommend my paper here:

  3. "if the yield curve is negatively sloped (the bank rate is higher than the natural rate) then a recession (deflationary forces) are to be expected. " what relation (if any) does this have with Adam Smith hypothesis concerning the relation between the profit rate and the interest rate?

    "But though it may be impossible to determine with any degree of precision, what are or
    were the average profits of stock, either in the present, or in ancient times, some notion may
    be formed of them from the interest of money. It may be laid down as a maxim that
    wherever a great deal can be made of the use of money, a great deal will commonly given
    for the use of it; and that wherever little can be made by it, less will commonly be given for
    it. According, therefore, as the usual market rate of interest varies in any country, we may
    be assured that the ordinary profits of stock must vary with it, must sink as it sinks, and rise
    as it rises. The progress of interest, therefore, may lead us to form some notion of the
    progress of profit." Wealth of nations page 88

  4. Classical authors in general, not just Smith, thought that competition implied that the rate of interest adjusted to the rate of profit. If the rate of interest was lower than the rate of profit borrowing would be advantageous, and increased borrowing would bring the rate of interest in line with the rate of profit. Most thought that the rate of profit determined the interest rate. There are some that thought that the rate of interest was the attractor of the rate of profit. However, for all the classical authors and Marx interest and profit were part of the surplus, whereas for the marginalist authors, including Wicksell, the determination of interest and profit by supply and demand in their respective markets. I highly recommend Carlo Panico's paper on the topic (Marx's analysis of the relationship between the rate of interest and the rate of profits, Cambridge Journal of Economics, 1980).


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