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Recession probabilities for the Eurozone at the zero lower bound: Challenges to the term spread and rise of alternatives

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  • Ralf Fendel
  • Nicola Mai
  • Oliver Mohr

Abstract

This paper examines the recession probability in the Eurozone within the next 12 months at the zero lower bound (ZLB) and explores two new perspectives: a revised measure of the traditional term spread and a modification to detect unstable dynamics driven by animal spirits. We find that the yield curve largely lost its forecasting ability at the ZLB. To remove the downward rigidity of short‐term rates, we suggest a modified version of the term spread which uses a “shadow policy rate,” rather than the 3‐month rate, as the front leg of the spread. We further show that a bivariate specification including both the current state of an indicator as well as its lagged deviation from its trend augments the predictive capability for most indicators significantly.

Suggested Citation

  • Ralf Fendel & Nicola Mai & Oliver Mohr, 2021. "Recession probabilities for the Eurozone at the zero lower bound: Challenges to the term spread and rise of alternatives," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 40(6), pages 1000-1026, September.
    • Handle: RePEc:wly:jforec:v:40:y:2021:i:6:p:1000-1026
    DOI: 10.1002/for.2751
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    References listed on IDEAS

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    Cited by:

    1. Donato Ceci & Andrea Silvestrini, 2023. "Nowcasting the state of the Italian economy: The role of financial markets," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 42(7), pages 1569-1593, November.
    2. Kajal Lahiri & Cheng Yang, 2022. "ROC approach to forecasting recessions using daily yield spreads," Business Economics, Palgrave Macmillan;National Association for Business Economics, vol. 57(4), pages 191-203, October.
    3. Kajal Lahiri & Cheng Yang, 2023. "A tale of two recession-derivative indicators," Empirical Economics, Springer, vol. 65(2), pages 925-947, August.
    4. Sabes, David & Sahuc, Jean-Guillaume, 2023. "Do yield curve inversions predict recessions in the euro area?," Finance Research Letters, Elsevier, vol. 52(C).

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