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Predicting Output and Inflation in Less Developed Financial Markets Using the Yield Curve: Evidence from Malaysia

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  • Abdul Majid, Muhamed Zulkhibri

Abstract

This paper investigates the role of the term spread to predict domestic output and inflation in less developed financial market with the focus on Malaysia bond market. By controlling for past values of the dependent variable, this paper finds that the term spread of various bond maturities contain relevant information about future output and inflation at short horizons. Besides that, we employ a probit model to assess the ability for the yield curve to predict future economic slowdown. The results suggest that the term spread has contributed significantly in the probability of predicting future economic slowdown. Despite the under-developed bond market, the findings point to the potential for bond yields to play a greater role in monetary analysis beyond conventional indicators. From the policy point of views, the results from our analysis suggest that there is a significant potential for incorporating more technical and model based approaches using the yield curve beyond the usual indicator analysis.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 29039.

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Date of creation: 01 Jan 2011
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Handle: RePEc:pra:mprapa:29039

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Keywords: Term spread; Forecasting; Monetary Policy; Malaysia;

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  1. James H. Stock & Mark W.Watson, 2003. "Forecasting Output and Inflation: The Role of Asset Prices," Journal of Economic Literature, American Economic Association, vol. 41(3), pages 788-829, September.
  2. Y. K. Tse, 1998. "Interest Rate Spreads And The Prediction Of Real Economic Activity: The Case Of Singapore," The Developing Economies, Institute of Developing Economies, vol. 36(3), pages 289-304, 09.
  3. Frederic S. Mishkin, 1991. "The Information in the Longer Maturity Term Structure about Future Inflation," NBER Working Papers 3126, National Bureau of Economic Research, Inc.
  4. Mehl, Arnaud, 2006. "The yield curve as a predictor and emerging economies," Working Paper Series, European Central Bank 0691, European Central Bank.
  5. Arturo Estrella, 2005. "Why Does the Yield Curve Predict Output and Inflation?," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 115(505), pages 722-744, 07.
  6. Ben S. Bernanke, 1990. "On the predictive power of interest rates and interest rate spreads," New England Economic Review, Federal Reserve Bank of Boston, issue Nov, pages 51-68.
  7. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 1(1), pages 19-46, January.
  8. Arturo Estrella & Gikas A. Hardouvelis, 1989. "The term structure as a predictor of real economic activity," Research Paper 8907, Federal Reserve Bank of New York.
  9. E. P. Davis & S. G. B. Henry, 1994. "The Use of Financial Spreads as Indicator Variables: Evidence for the United Kingdom and Germany," IMF Staff Papers, Palgrave Macmillan, vol. 41(3), pages 517-525, September.
  10. Marcelle Chauvet & Simon Potter, 2001. "Forecasting recessions using the yield curve," Staff Reports, Federal Reserve Bank of New York 134, Federal Reserve Bank of New York.
  11. Zuliu Hu, 1993. "The Yield Curve and Real Activity," IMF Working Papers 93/19, International Monetary Fund.
  12. Frederic S. Mishkin, 1991. "A Multi-Country Study of the Information in the Term Structure about Future Inflation," NBER Working Papers 3125, National Bureau of Economic Research, Inc.
  13. Fama, Eugene F, 1975. "Short-Term Interest Rates as Predictors of Inflation," American Economic Review, American Economic Association, American Economic Association, vol. 65(3), pages 269-82, June.
  14. Mishkin, Frederic S., 1991. "A multi-country study of the information in the shorter maturity term structure about future inflation," Journal of International Money and Finance, Elsevier, Elsevier, vol. 10(1), pages 2-22, March.
  15. 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.
  16. Plosser, Charles I. & Geert Rouwenhorst, K., 1994. "International term structures and real economic growth," Journal of Monetary Economics, Elsevier, Elsevier, vol. 33(1), pages 133-155, February.
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Cited by:
  1. Fabian Lipinsky & Li Lian Ong, 2014. "Asia’s Stock Markets: Are There Crouching Tigers and Hidden Dragons?," IMF Working Papers 14/37, International Monetary Fund.

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