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Predicting Australian Growth and Recession Via the Yield Curve

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  • Karunaratne, Neil Dias

    (Department of Economics, The University of Queensland)

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    Abstract

    This slope of the yield curve has been estimated using quarterly data on real GDP and the nominal spread is proxied by the difference in returns from the 10 year bond rate and the 90 day bill rate. The time-series analysis after unit root tests using stationary variables revealed that the yield curve gives the best forecasts on real activity over a forecast horizon of one year (4 quarters) ahead. Non-nested tests of rival models of alternative financial indicators demonstrated that the yield curve outperforms other financial indicators as a robust predictor of future real activity. The Probit model forecasts of recessions indicated that the inverted slope of the yield curve for 4-quarter horizon gave the best recession prediction for Australia. The probit model predictions also gave probability estimates for the occurrence of recessions for different nominal spreads or slopes of the yield curve. The probit model predictions of recessions improved dramatically when a dynamic lag structure was incorporated. Empirical evidence demonstrates that the yield curve outperforms other financial indicators as a predictor of a recessions in Australia. It is a simple operational tool that can be validated using up-to-date data.

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    Bibliographic Info

    Article provided by Queensland University of Technology (QUT), School of Economics and Finance in its journal Economic Analysis and Policy (EAP).

    Volume (Year): 32 (2002)
    Issue (Month): 2 (June Special Issue)
    Pages: 233-250

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    Handle: RePEc:eap:articl:v:32:y:2002:i:2:p:233-250

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    1. Michael Dueker, 1997. "Strengthening the case for the yield curve as a predictor of U.S. recessions," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 41-51.
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    3. Bernard, Henri & Gerlach, Stefan, 1998. "Does the Term Structure Predict Recessions? The International Evidence," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 3(3), pages 195-215, July.
    4. Lakshman Alles, 1995. "The Australian Term Structure as a Predictor of Real Economic Activity," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 28(4), pages 71-85.
    5. Shiller, Robert J. & Huston McCulloch, J., 1990. "The term structure of interest rates," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 1, chapter 13, pages 627-722 Elsevier.
    6. Catherine Bonser-Neal & Timothy R. Morley, 1997. "Does the yield spread predict real economic activity? : a multicountry analysis," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 37-53.
    7. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February.
    8. David McMillan, 2002. "Interest rate spread and real activity: evidence for the UK," Applied Economics Letters, Taylor & Francis Journals, vol. 9(3), pages 191-194.
    9. Davidson, Russell & MacKinnon, James G, 1981. "Several Tests for Model Specification in the Presence of Alternative Hypotheses," Econometrica, Econometric Society, vol. 49(3), pages 781-93, May.
    10. Sharon Kozicki, 1997. "Predicting real growth and inflation with the yield spread," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 39-57.
    11. Harvey, Campbell R., 1988. "The real term structure and consumption growth," Journal of Financial Economics, Elsevier, vol. 22(2), pages 305-333, December.
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