The term structure of interest rates as a leading indicator of economic activity: A technical note
AbstractThe spread between long-term and short-term interest rates has proven to be an excellent predictor of changes of economic activity in Canada. As a general rule, when long-term interest rates have been much above short-term rates, strong increases in output have followed within about a year; however, whenever the yield curve has been inverted for any extended period of time, a recession has followed. Similar findings exist for other countries, including the United States. But although Canadian and U.S. interest rates generally move quite closely together, the Canadian yield curve has been distinctly better at predicting future Canadian output. The explanation given for this result is that the term spread has reflected both current monetary conditions, which affect short-term interest rates, and expected real returns on investment and expectations of inflation, which are the main determinants of long-term rates. This article is mainly a summary of econometric work done at the Bank. It also touches on some of the extensive recent literature in this area.
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Bibliographic InfoArticle provided by Bank of Canada in its journal Bank of Canada Review.
Volume (Year): 1994-1995 (1995)
Issue (Month): Winter ()
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Find related papers by JEL classification:
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
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- David R. Johnson, 1997. "Expected Inflation in Canada 1988-1995: An Evaluation of Bank of Canada Credibility and the Effect of Inflation Targets," Canadian Public Policy, University of Toronto Press, vol. 23(3), pages 233-258, September.
- David Longworth & Brian O´Reilly, 2002.
"The Monetary Policy Transmission Mechanism and Policy Rules in Canada,"
Central Banking, Analysis, and Economic Policies Book Series,
in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy: Rules and Transmission Mechanisms, edition 1, volume 4, chapter 13, pages 357-392
Central Bank of Chile.
- David Longworth & Brian O’Reilly, 2000. "The Monetary Policy Transmission Mechanism and Policy Rules in Canada," Working Papers Central Bank of Chile 72, Central Bank of Chile.
- Jim Day & Ron Lange, 1997. "The Structure of Interest Rates in Canada: Information Content about Medium-Term Inflation," Working Papers 97-10, Bank of Canada.
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