The Predictive Power of the User Cost Spread for Economic Recession in China and the US

Abstract

The predictive power of the yield curve slope, or the yield spread is well established in the United States (US) and European Union (EU) countries since 1998. However, there exists a gap in the literature on the predictive power of the yield spread on the Chinese economy. This paper provides a different leading recession indicator using the Chinese and US economy as comparative examples: the user cost spread, being the difference of the opportunity costs of holding government securities of different maturities. We argue that the user cost spread, based on the Divisia monetary aggregate data like the ones produced by the Center for Financial Stability, provides improved predictive ability and a better intuitive explanation based on changes in the user cost price of holding bonds.

Global Economy: New Risks and Leadership Problems

“…Therefore, the subject of crisis is relevant today. In this regard, a certain interest represents research about the effects of harvest on recession in the USA and China (Chang et al 2019), relending of the private sector (White 2010) and financial aid programs of the IMF during Asian crises (Shin 2017).…”

Do Divisia monetary aggregates help forecast exchange rates in a negative interest rate environment?

“…Similarly, Schunk (2001) showed that using Divisia aggregates improves the accuracy of US real GDP and GDP deflator predictions. Also, Binner et al (2005) finds there are strong indications that Divisia outperforms simple-sum aggregates in a non-linear framework when forecasting inflation for the euro area, whilst the predictive power of the User Cost Price spread for economic recessions in both China and the USA has been investigated recently by Chang, Mattson, and Tang (2019). Belongia and Ireland (2015) show that Divisia monetary aggregates contain useful information for central bankers that help better describe the behavior of macroeconomic variables and Belongia and Ireland (2016) provide evidence of correlation between pro-cyclical movements in the money stock and output, especially when using Divisia monetary aggregates.…”

“…As stated in Section 3 above, a sophisticated Divisia index measure, under fairly general assumptions, represents the ideal aggregate measure of 'liquidity services' available in the economy and is therefore potentially of great interest to monetary policymakers aiming at understanding the effects of monetary policy on the aggregate economy, Keating et al (2019). We follow Chang, Mattson, and Tang (2019) and take the view that the Divisia method of pricing incorporates the segmented markets hypothesis by treating assets of different degrees of liquidity and different maturities as imperfect substitutes. Indeed, one of the main contributions of the Divisia monetary aggregate literature is to uncover and acknowledge the failings of the simple-sum approach that treats all monetary assets as perfect substitutes.…”