Hence although a yield curve seems steep it can be, according to my definition, inverted.
This is especially true when the short-term risk free rate is 0%.
Otherwise obviously, there would ever be an inverted yield curve for short-term risk free rates = 0%.
I call The Crash Trigger the yield curve when The Crash Occurs.
The Yield Curve of Keynes' Liquidity Trap and The Crash Trigger.
In green the Yield Curve of Keynes Liquidity Trap. In orange The Crash Trigger.
For someone not using my model they both seem very steep, don't they?
When the Market receives a Random Shock, the yield curve twists discontinuously from The Crash Trigger to the Yield Curve of Keynes' Liquidity Trap.
Irrational Exuberance:
The inverted yield curve is the result of investors buying overpriced long-term assets.
It is the result of what Alan Greenspan termed Irrational Exuberance.
"Clearly, sustained low inflation implies less uncertainty about the future,
and lower risk premiums imply higher prices of stocks and other earning assets.
We can see that in the inverse relationship exhibited by
price/earnings ratios and the rate of inflation in the past.
But how do we know when irrational exuberance has unduly escalated asset values, which then
become subject to unexpected and prolonged contractions as they have in Japan over the past decade?
And how do we factor that assessment into monetary policy?
We as central bankers need not be concerned if a collapsing financial asset bubble does not
threaten to impair the real economy, its production, jobs, and price stability.
Indeed, the sharp stock market break of 1987 had few negative consequences for the economy.
But we should not underestimate or become complacent about the complexity of
the interactions of asset markets and the economy. Thus, evaluating shifts
in balance sheets generally, and in asset prices particularly,
must be an integral part of the development of monetary policy."
Chairman Alan Greenspan
The Challenge of Central Banking in a Democratic Society.
At the Annual Dinner and Francis Boyer Lecture of
The American Enterprise Institute for Public Policy Research,
Washington, D.C. December 5th, 1996
Greenspan Conundrum:
The inversion of the yield curve tends to increase, even faster of late, it is the famous Greenspan Conundrum.
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