Keywords: Yield spread, business cycles, monetary policy.
Abstract: 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.
Full paper (318 KB PDF)
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Last update: August 26, 2004