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The Yield Spread as a Symmetric Predictor of Output and Inflation

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  • Hardouvelis, Gikas A
  • Malliaropoulos, Dimitrios

Abstract

We present evidence that the predictive ability of the yield spread for short-run inflation is related to its predictive ability for economic activity. In particular, an increase in the slope of the term structure predicts an increase in output growth and a decrease in inflation of equal magnitude. In order to explain this finding, we develop a monetary asset-pricing model with sticky goods prices. Sticky prices imply that economic disturbances generate predictable changes in output and inflation, thus allowing for intertemporal substitution effects and changes in the slope of the yield curve. We derive analytic solutions of the covariance between the nominal yield spread and future output growth and inflation and show that a moderate degree of price stickiness and relatively high degree of intertemporal substitution can account for the observed correlations in the US data over the period 1960:Q1 - 2003:Q2.

Suggested Citation

  • Hardouvelis, Gikas A & Malliaropoulos, Dimitrios, 2004. "The Yield Spread as a Symmetric Predictor of Output and Inflation," CEPR Discussion Papers 4314, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:4314
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    References listed on IDEAS

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    Cited by:

    1. Mehl, Arnaud, 2006. "The yield curve as a predictor and emerging economies," BOFIT Discussion Papers 18/2006, Bank of Finland, Institute for Economies in Transition.
    2. Hiona Balfoussia & Mike Wickens, 2006. "Extracting inflation expectations from the term structure: the Fisher equation in a multivariate SDF framework," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 11(3), pages 261-277.
    3. Arnaud Mehl, 2009. "The Yield Curve as a Predictor and Emerging Economies," Open Economies Review, Springer, pages 683-716.
    4. Arnaud Mehl, 2009. "The Yield Curve as a Predictor and Emerging Economies," Open Economies Review, Springer, pages 683-716.

    More about this item

    Keywords

    general equilibrium; term structure of interest rates;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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