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Monetary policy and the information content of the yield spread

  • Michael Feroli
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    This paper demonstrates that the ability of the yield spread to predict output fluctuations is contingent on the monetary authority's reaction function. In particular, expectations of monetary policy actions are crucial for the spread to predict output conditional on the short-rate. Furthermore, numerical experiments suggest that the post-1979 decrease in the yield spread's predictive power is due to a shift in the monetary policy reaction function at that time.

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    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2004-44.

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    Date of creation: 2004
    Date of revision:
    Handle: RePEc:fip:fedgfe:2004-44
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    1. Peter N. Ireland, 2000. "Sticky-Price Models of the Business Cycle: Specification and Stability," NBER Working Papers 7511, National Bureau of Economic Research, Inc.
    2. Frederic S. Mishkin, 1990. "The Information in the Longer Maturity Term Structure about Future Inflation," The Quarterly Journal of Economics, Oxford University Press, vol. 105(3), pages 815-828.
    3. 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.
    4. Hamilton, James Douglas & Kim, Dong Heon, 2000. "A Re-examination of the Predictability of Economic Activity Using the Yield Spread," University of California at San Diego, Economics Working Paper Series qt69v8p1m9, Department of Economics, UC San Diego.
    5. Franklin Allen & Douglas Gale, 1976. "Optimal Financial Crises," Center for Financial Institutions Working Papers 97-01, Wharton School Center for Financial Institutions, University of Pennsylvania.
    6. 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.
    7. Unknown, 1998. "Discussion," Journal of Economic Psychology, Elsevier, vol. 19(5), pages 651-652, October.
    8. Marvin Goodfriend, 1998. "Using the term structure of interest rates for monetary policy," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 13-30.
    9. José Angulo & N. Cressie & C. Wikle & P. Soidán & M. Bande & C. Glasbey & John Kent & Ana Militino & Michael Stein, 1998. "Discussion," TEST: An Official Journal of the Spanish Society of Statistics and Operations Research, Springer;Sociedad de Estadística e Investigación Operativa, vol. 7(2), pages 283-285, December.
    10. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
    11. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
    12. 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.
    13. Unknown, 1998. "Discussion," Journal of Economic Psychology, Elsevier, vol. 19(5), pages 645-650, October.
    14. Unknown, 1998. "Discussion," Journal of Economic Psychology, Elsevier, vol. 19(5), pages 619-643, October.
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