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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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    File URL: http://www.federalreserve.gov/pubs/feds/2004/200444/200444abs.html
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    File URL: http://www.federalreserve.gov/pubs/feds/2004/200444/200444pap.pdf
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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
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    Handle: RePEc:fip:fedgfe:2004-44
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    Web page: http://www.federalreserve.gov/

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    1. Franklin Allen & Douglas Gale, 1998. "Optimal Financial Crises," Journal of Finance, American Finance Association, vol. 53(4), pages 1245-1284, 08.
    2. Hamilton, James D & Kim, Dong Heon, 2002. "A Reexamination of the Predictability of Economic Activity Using the Yield Spread," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(2), pages 340-60, May.
    3. Newey, Whitney K & West, Kenneth D, 1987. "A Simple, Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix," Econometrica, Econometric Society, vol. 55(3), pages 703-08, May.
    4. Ireland, Peter N., 2001. "Sticky-price models of the business cycle: Specification and stability," Journal of Monetary Economics, Elsevier, vol. 47(1), pages 3-18, February.
    5. Frederic S. Mishkin, 1991. "The Information in the Longer Maturity Term Structure about Future Inflation," NBER Working Papers 3126, National Bureau of Economic Research, Inc.
    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 619-643, October.
    8. 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.
    9. Unknown, 1998. "Discussion," Journal of Economic Psychology, Elsevier, vol. 19(5), pages 651-652, October.
    10. Arturo Estrella & Gikas A. Hardouvelis, 1989. "The term structure as a predictor of real economic activity," Research Paper 8907, Federal Reserve Bank of New York.
    11. 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.
    12. 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.
    13. 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, vol. 7(2), pages 283-285, December.
    14. Unknown, 1998. "Discussion," Journal of Economic Psychology, Elsevier, vol. 19(5), pages 645-650, October.
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