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Yield spreads as predictors of economic activity: a real-time VAR analysis

  • N. Kundan Kishor
  • Evan F. Koenig

We undertake a real-time VAR analysis of the usefulness of the term spread, the junk-bond spread, the ISM's New Orders Index, and broker/dealer equity for predicting growth in non-farm employment. To get around the "apples and oranges" problem described by Koenig, Dolmas and Piger (2003), we augment each VAR we consider with a flexible state-space model of employment revisions. This methodology produces jobs forecasts consistently superior to those obtained using conventional VAR analysis. They are also superior to Federal Reserve Greenbook forecasts and to median forecasts from the Survey of Professional Forecasters. The junk-bond spread is by far the best single predictor of future jobs growth. However, the term spread has some incremental predictive power at medium-to-long horizons. The incremental predictive power of broker/dealer equity, while small, exceeds that of the ISM index at every horizon.

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File URL: http://dallasfed.org/assets/documents/research/papers/2010/wp1008.pdf
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Paper provided by Federal Reserve Bank of Dallas in its series Working Papers with number 1008.

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Date of creation: 2010
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Handle: RePEc:fip:feddwp:1008
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  1. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediaries, financial stability, and monetary policy," Staff Reports 346, Federal Reserve Bank of New York.
  2. Arturo Estrella & Anthony P. Rodrigues & Sebastian Schich, 2003. "How Stable is the Predictive Power of the Yield Curve? Evidence from Germany and the United States," The Review of Economics and Statistics, MIT Press, vol. 85(3), pages 629-644, August.
  3. Glenn D. Rudebusch & John C. Williams, 2007. "Forecasting recessions: the puzzle of the enduring power of the yield curve," Working Paper Series 2007-16, Federal Reserve Bank of San Francisco.
  4. Arturo Estrella & Frederic S. Mishkin, 1996. "Predicting U.S. recessions: financial variables as leading indicators," Research Paper 9609, Federal Reserve Bank of New York.
  5. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers 98-03, C.V. Starr Center for Applied Economics, New York University.
  6. Estrella, Arturo & Hardouvelis, Gikas A, 1991. " The Term Structure as a Predictor of Real Economic Activity," Journal of Finance, American Finance Association, vol. 46(2), pages 555-76, June.
  7. Menzie D. Chinn & Kavan J. Kucko, 2010. "The Predictive Power of the Yield Curve across Countries and Time," NBER Working Papers 16398, National Bureau of Economic Research, Inc.
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