Keywords: Interest rates, forecasting, GDP growth, term premiums, probit
Abstract: The slope of the Treasury yield curve has often been cited as a leading economic indicator, with
inversion of the curve being thought of as a harbinger of a recession. In this paper, I consider
a number of probit models using the yield curve to forecast recessions. Models that use both the
level of the federal funds rate and the term spread give better in-sample fit, and better out-of-sample
predictive performance, than models with the term spread alone. There is some evidence that controlling
for a term premium proxy as well may also help. I discuss the implications of the current shape of the
yield curve in the light of these results, and report results of some tests for structural stability
and an evaluation of out-of-sample predictive performance.
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Last update: March 17, 2006