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The Term Spread as a Predictor of Financial Instability

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Abstract

The term spread is the difference between interest rates on short- and long-dated government securities. It is often referred to as a predictor of the business cycle. In particular, inversions of the yield curve—a negative term spread—are considered an early warning sign. Such inversions typically receive a lot of attention in policy debates when they occur. In this post, we point to another property of the term spread, namely its predictive ability for financial crisis events, both internationally and in historical U.S. data. We study the predictive power of the term spread for financial instability events in the United States and internationally over the past 150 years.

Suggested Citation

  • Dean Parker & Moritz Schularick, 2021. "The Term Spread as a Predictor of Financial Instability," Liberty Street Economics 20211124, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednls:93395
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    File URL: https://libertystreeteconomics.newyorkfed.org/2021/11/the-term-spread-as-a-predictor-of-financial-instability/
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    Cited by:

    1. Maximilian Grimm & Òscar Jordà & Moritz Schularick & Alan M. Taylor, 2023. "Loose Monetary Policy and Financial Instability," Working Paper Series 2023-06, Federal Reserve Bank of San Francisco.
    2. Li, Xiang & Su, Dan, 2022. "Surges and instability: The maturity shortening channel," Journal of International Economics, Elsevier, vol. 139(C).

    More about this item

    Keywords

    yield curves; financial crisis;

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • N0 - Economic History - - General
    • G01 - Financial Economics - - General - - - Financial Crises

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