A. The current (April 12, 2017) interest rate on the 3-Month US Treasury is 0.81%. In financial literature this rate is considered to be the “risk free rate” of interest, which includes the rate of time preference and the inflation premium (the inflation premium is based on expected inflation for the duration – maturity – of the Treasury). The current rate (April 12, 2017) on the 10-year US Treasury is 2.28%. Use the “extended” version of the Fisher Equation (R = R* + IP + LP + MRP + DRP) to explain in detail why these interest rates differ.
B. Now assume that one year from now, the interest rate on the 3-month Treasury is 5% and the rate on the 10-year Treasury is 1.7%. Using economic reasoning and the extended Fisher Equation, explain the phenomenon that is taking place. What is happening to the “risk profile” of the US economy?