Predicting Recessions in Germany Using the German and the US Yield Curve

The purpose of this study is to verify the ability of the German treasury yield curve and its components of expectations and term premium to predict recessions in Germany. The German yield curve slope can predict recessions in Germany but with a worse accuracy than the US yield curve predicts recessions in the US. The predictive power of the German yield curve is driven by expectations and reinforced by signals from the term premium component. However, an analysis of the shrunk sub-sample until 1996 shows that the German yield curve’s ability to predict recessions has deteriorated in recent decades. Also, the significance of control variables representing the stance of monetary policy has weakened in recent decades, although they were strong and important predictors of the recession in Germany until 1996. As policy interest rate fell to the effective lower bound, the central bank resorted to other instruments to ease credit conditions, and consequently, policy rate (and its difference from the neutral interest rate) lost some of its meaning as a gauge of monetary accommodation. Orders in manufacturing markedly improve the recession forecast, although they are not early indicators of an impending recession. Although the US yield curve slope may to some extent predict recessions in Germany, its significance completely disappears in the presence of the German yield curve. The predictive power of the US yield curve was greater before 1996 than in the full sample horizon.