Does the Yield Curve Predict Output?

Abstract

Does the yield curve have the ability to predict output and recessions? At some times and in certain places, of course! But when and where, which aspects of the curve matter most, and which economic forces account for the predictive ability are matters of dispute. Over the years, an increasingly sophisticated set of tools, both statistical and theoretical, has addressed the issue. For the United States, an inverted yield curve, particularly when the spread between the yield on 10-year and 3-month Treasuries becomes negative, has been a robust indicator of recessions in the post–World War II period. The spread also predicts future real GDP growth for the United States, although the forecast ability varies by time period in ways that appear to depend on monetary policy. The evidence is less clear in other countries, but the yield curve shows some predictive ability for the United Kingdom and Germany, among others. Expected final online publication date for the Annual Review of Financial Economics, Volume 13 is March 2021. Please see http://www.annualreviews.org/page/journal/pubdates for revised estimates.

Low Interest Rates and the Predictive Content of the Yield Curve

“…In turn, considering low rate periods is related to the question of how monetary regimes affect the predictive ability of the yield curve: Bordo and Haubrich (2008a,b) have suggested that the monetary regime may play a role, Giacomini and Rossi (2006) provide evidence that changes in monetary policy have led to breakdowns in predictive accuracy, and Benati and Goodhart (2008) show that changing inflation persistence matters, a finding that has extensive overlap with the first question, as short rates are often used as an indicator of monetary policy. These are all part of the rich literature that documents and explains the predictive ability of the yield curve; see the surveys by Estrella (2005), Wheelock and Wohar (2009) and Haubrich (2021). As such it also contributes to understanding the economics of low interest rate environments, as in Ramey and Zubairy (2018), Sims and Wu (2020), and Eggertsson and Woodford (2003).…”