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The Predictive Power of Interest Rates Spread for Economic Activity

  • Raffaele Passaro

    ()

    (University of Siena)

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    Since the 1980s, economists argued that the spread between the long-and short-term interest rates is a good predictor of future economic activity. Developing Estrella (2006) study, I investigate the ability of the interest rate spread to predict USA and Germany recessions using a probit model. The results show that the slope of the yield curve well predicts recession periods. I also compare the performance of the spread to the performance of the Chicago Federal Nation Index (CFNAI) — a credited leading indicator for the economic activity of the US — finding out that the yield-spread based forecast anticipates by several months the CFNAI forecast.

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    File URL: http://www.rivistapoliticaeconomica.it/2007/nov-dic/pdf/passaro_ing.pdf
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    Article provided by SIPI Spa in its journal Rivista di Politica Economica.

    Volume (Year): 97 (2007)
    Issue (Month): 6 (November-December)
    Pages: 81-112

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    Handle: RePEc:rpo:ripoec:v:97:y:2007:i:6:p:81-112
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    1. Estrella, Arturo & Mishkin, Frederic S., 1997. "The predictive power of the term structure of interest rates in Europe and the United States: Implications for the European Central Bank," European Economic Review, Elsevier, vol. 41(7), pages 1375-1401, July.
    2. Bernard, Henri J & Gerlach, Stefan, 1998. "Does the Term Structure Predict Recessions? The International Evidence," CEPR Discussion Papers 1892, C.E.P.R. Discussion Papers.
    3. Arturo Estrella, 2005. "Why Does the Yield Curve Predict Output and Inflation?," Economic Journal, Royal Economic Society, vol. 115(505), pages 722-744, 07.
    4. Michael Dotsey & Christopher Otrok, 1995. "The rational expectations hypothesis of the term structure, monetary policy, and time-varying term premia," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 65-81.
    5. Michael Dotsey, 1998. "The predictive content of the interest rate term spread for future economic growth," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 31-51.
    6. James H. Stock & Mark W. Watson, 1989. "New Indexes of Coincident and Leading Economic Indicators," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 351-409 National Bureau of Economic Research, Inc.
    7. Joseph G. Haubrich & Ann M. Dombrosky, 1996. "Predicting real growth using the yield curve," Economic Review, Federal Reserve Bank of Cleveland, issue Q I, pages 26-35.
    8. Zuliu Hu, 1993. "The Yield Curve and Real Activity," IMF Working Papers 93/19, International Monetary Fund.
    9. Harvey, Campbell R., 1988. "The real term structure and consumption growth," Journal of Financial Economics, Elsevier, vol. 22(2), pages 305-333, December.
    10. Hardouvelis, Gikas A., 1994. "The term structure spread and future changes in long and short rates in the G7 countries: Is there a puzzle?," Journal of Monetary Economics, Elsevier, vol. 33(2), pages 255-283, April.
    11. 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.
    12. Arturo Estrella & Mary R. Trubin, 2006. "The yield curve as a leading indicator: some practical issues," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 12(Jul).
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