Question

If investors expect the rate of inflation to increase sharply in the future, then should we be surprised to see an upward-sloping yield curve?

1) Yes, we should be surprised
2) No, we should not be surprised
3) Cannot be determined

Answer 1

If investors expect a sharp increase in inflation, it would not be surprising to see an upward-sloping yield curve.

Step-by-step explanation:

An upward-sloping yield curve means that long-term interest rates are higher than short-term interest rates. If investors expect the rate of inflation to increase sharply in the future, they will demand higher compensation for lending money over a longer period of time. This is because inflation erodes the purchasing power of future dollars.

When inflation is expected to be high, investors will require higher interest rates on long-term bonds to offset the potential loss in value. Therefore, if investors expect a sharp increase in inflation, it would not be surprising to see an upward-sloping yield curve.

For example, if the expected inflation rate is 5% and the current short-term interest rate is 3%, investors would demand a higher interest rate (let's say 6%) for a long-term bond to compensate for the expected increase in inflation. This would result in an upward-sloping yield curve.