4. (14 points; 7 each) When the yield curve briefly inverted this March, some commentators suggested this signaled that the economy would soon enter a recession. This conclusion rests on the assumptions that recessions are accompanied by lower interest rates, and that an inverted yield curve indicates interest rates are expected to decline.

a. If the Pure Expectations Model of the term structure holds, is it correct to say an inverted yield curve signals interest rates are expected to decline? Explain why or why not.

b. If, instead, the Liquidity Preference Model holds, how would your answer to (a) change?