Discuss the relationship between the shape of the yield curve and the monetary and fiscal policy mix projected by Hadpret.

Currently, Eastland’s currency is fixed relative to the currency of the country of Northland, and Eastland maintains policies that allow unrestricted capital flows. Hadpret examines the relationship between interest rates and exchange rates. He considers three possible scenarios for the Eastland economy:

Robert Hadpret is the chief economist at Agree Partners, an asset management firm located in the developed country of Eastland. He has prepared an economic report on Eastland for the firm’s asset allocation committee. Hadpret notes that the composite index of leading economic indicators has declined for three consecutive months and that the yield curve has inverted. Private sector borrowing is also projected to decline. Based on these recent events, Hadpret predicts an economic contraction and forecasts lower inflation and possibly deflation over the next 12 months.
Helen Smitherman, a portfolio manager at Agree, considers Hadpret’s economic forecast when determining the tactical allocation for the firm’s Balanced Fund (the fund). Smitherman notes that the fund has considerable exposure to real estate, shares of asset-intensive and commodity-producing firms, and high-quality debt. The fund’s cash holdings are at cyclical lows.

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Scenario Shift in policy restricting capital flows 1: Scenario Shift in policy allowing the currency to float 2: Scenario 3: Shift in investor belief toward a lack of full credibility that the exchange rate will be fixed forever