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Economic downturn and the yield curve: Evidence from Canada and the US

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  • Libo Xu

    (Lakehead University)

Abstract

The paper utilized the Sahm rule recession indicator to examine the relationship between the yield curve shape and recession risk. In doing so, we constructed the recession indicator and estimated a latent factor model that allows a rich interdependence between bond yields and the indicator in Canada and the US. The results based on impulse response functions confirm the predictive power of the yield curve’s slope on the future recession. Moreover, the quantitative analysis also shows that a downward shift in the yield curve and a decline in the yield curve’s curvature indicate a higher recession risk in the future. Forecast error variance decompositions highlighted the contribution of the information, which is extracted from the shape of the yield curve, to the variability in the recession risk in the long run.

Suggested Citation

  • Libo Xu, 2025. "Economic downturn and the yield curve: Evidence from Canada and the US," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 49(2), pages 536-567, June.
    • Handle: RePEc:spr:jecfin:v:49:y:2025:i:2:d:10.1007_s12197-025-09716-y
    DOI: 10.1007/s12197-025-09716-y
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    References listed on IDEAS

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    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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