Are “Normal” Yield Curves Actually Normal?

The US yield curve usually slopes upward. Hence positively sloped yield curves are termed ‘normal’ and negatively sloped yield curves are termed ‘inverted’. But are “normal” yield curves actually normal?

The US business cycle has an unusual feature, an absence of soft landings. A soft landing is when unemployment recovers to the natural rate, and then stays low for at least four years. The only plausible example is 1966-69, but that wasn’t really a soft landing because it came at the expense of rapidly accelerating inflation. The plane soared off into the stratosphere before the wheels even touched the runway. Otherwise, we have only a year or two of stable and low unemployment, before the next recession.

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He not busy being born is busy dying — B. Dylan

So 90% of the time we are either recovering (mostly with a normal yield curve) or in recession (mostly with a normal yield curve.) Inverted curves tend to occur right before a recession when unemployment is low. But what if we did have a true soft landing—persistent low unemployment without accelerating inflation? Would the yield curve be flat? After all, when output is already near the natural rate, you don’t expect further recovery. You don’t expect the future economy to be better (stronger) than the present.

So I decided to seek out a country that did have a soft landing—Britain from 2001-08:

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2001-08: Not busy being born or busy dying

Notice that in 1991, the UK entered recession almost immediately after the unemployment rate stopped falling—the US pattern. But in 2001, unemployment reached the low 5s and stayed near there until mid-2008. So how about the UK yield curve? Below I have data from 2000-08, using June data in each case. The first number is the nominal yield on 6-month UK T-bonds, and the second number is the yield on 10-year bonds. I’m not used to using UK data, so someone tell me if I made a mistake:

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