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Why Can the Yield Curve Predict Output Growth, Inflation, and Interest Rates? An Analysis with an Affine Term Structure Model

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  • Hibiki Ichiue

    (Bank of Japan)

Abstract

The literature provides evidence that term spreads help predict output growth, inflation, and interest rates. This paper integrates and explains these predictability results by using an affine term structure model with observable macroeconomic factors for U.S. data. The results suggest that consumers are willing to pay a higher premium for a consumption hedge during a higher inflation regime. This causes term spreads to react to inflation shocks, which proves useful for prediction. We also find that term spreads using the short end of the yield curve have less predictive power than many other spreads. We attribute this to monetary policy inertia.

Suggested Citation

  • Hibiki Ichiue, 2004. "Why Can the Yield Curve Predict Output Growth, Inflation, and Interest Rates? An Analysis with an Affine Term Structure Model," Bank of Japan Working Paper Series 04-E-11, Bank of Japan.
  • Handle: RePEc:boj:bojwps:04-e-11
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    File URL: http://www.boj.or.jp/en/research/wps_rev/wps_2004/data/wp04e11.pdf
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    References listed on IDEAS

    as
    1. Dewachter, Hans & Lyrio, Marco, 2006. "Macro Factors and the Term Structure of Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(1), pages 119-140, February.
    2. 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.
    3. Roberds, William & Whiteman, Charles H., 1999. "Endogenous term premia and anomalies in the term structure of interest rates: Explaining the predictability smile," Journal of Monetary Economics, Elsevier, vol. 44(3), pages 555-580, December.
    4. N. Gregory Mankiw & Jeffrey A. Miron, 1986. "The Changing Behavior of the Term Structure of Interest Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 101(2), pages 211-228.
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    More about this item

    Keywords

    Term structure; Monetary policy; VAR;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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