The Inverted Yield Curve and the Components of GDP
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Published
Mar 1, 2014
Abstract
When 3-month Treasury rates are greater than 10 -year Treasury rates an inverted yield curve occurs. When this state is reached some argue that a recession is on the horizon, typically 6 months to a year down the road. Here, I reframe the question of whether inverted yield curves predict recessions in the US and ask what an inverted yield curve predicts. Using a Probit model I find that when 10-year US Treasury bonds yield less than 3-month US Treasury bills, a US recession, while probable, is not certain. Moreover, I find that indeed the strength of this indicator has weakened over the last 20 years. However, my findings do not suggest that an inverted yield curve provides no information about the future. In fact, I find that an inverted yield curve strongly predicts movements in the consumer durables and fixed private investment series of US GDP.
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Keywords
Yield CurveGDPFederal Funds RateMonetary Policy
References
• Ang, A., Piazzesi, M., and Wei, M. (2006). What does the yield curve tell us about GDP growth? Journal of Econometrics, 131(1-2), 359-403.
• Bonser-Neal, C. and Morley, T. (1997). Does the yield spread predict real economic activity? Amulticountry analysis. Federal Reserve Bank of Kansas City Economic Review, 3rd Quarter, 37-53.
• Brunetti, M., and Torricelli, C., (2009). Economic activity and recession probabilities: information content and predictive power of the term spread in Italy. Applied Economics, 41, 2309- 2322.
• Butler, L. (1978). Recession? - A Market View. Federal Reserve Bank of San Francisco Weekly Letter, December 15.
• Dotsey, M. (1998). The predictive content of the interest rate term spread for future economic growth. Federal Reserve Bank of Richmond Economic Review, 3rd Quarter, 31-51.
• Erdogan, O., Bennett, P.B. and Ozyildirim, C. (2013). Predicting U.S. Recessions: Yield Curve and Stock Market Liquidity Deviation as Leading Indicators. 20th Annual Conference of the Multinational Finance Society, Turkey.
• Estrella, A. (2005). Why does the yield curve predict output and inflation? Economic Journal, 115, 722-744.
• Estrella, A. and Hardouvelis, G.A. (1991). The Term Structure as a Predictor of Real Economic Activity. Journal of Finance, 46(2), 555-76.
• Estrella, A. and Mishkin, F.S. (1997). Is there a role for monetary aggregates in the conduct of monetary policy? Journal of Monetary Economics, 40(2), 279-304.
• Estrella, A. and Mishkin, F.S. (1998). Predicting U.S. Recessions: Financial Variables As Leading Indicators. Review of Economics and Statistics, 80(1), 45-61.
• Federal Reserve Bank of Cleveland: Http://www.clevelandfed.org.” Yield Curve and Predicted GDP Growth. N.p., n.d. Web. 03 June 2013.
• Furlong, F.T. (1989). The Yield Curve and Recessions. Federal Reserve Bank of San Francisco Weekly Letter, March 10.
• Haubrich, J.G. and Dombrosky, A.M. (1996). Predicting real growth using the yield curve. Economic Review, 1996 Q1, 26-35.
• Khomo, M.M., and Aziakpono, M.M. (2007). Forecasting recessions in South Africa: a comparison of the yield curve and other economic indicators. South African Journal of Economics, 75(2), 194-212.
• Kim, C.J. and Nelson, C.R. (1999). Has the U.S. Economy Become More Stable? A Bayesian Approach Based on a Markov-Switching Model of the Business Cycle. Review of Economics and Statistics, 81(4), 608-16.
• Mohapi, T.A. and Botha, I. (2013). The explanatory power of the yield curve in predicting recessions in South Africa. International Business and Economics Research Journal, 12(6), 613-634.
• Moneta, F. (2005). Does the yield spread predict recessions in the Euro Area? International Finance, 8(2), 263-301.
• Moolman, E. (2002). The term structure as a predictor of recessions. Journal for Studies in Economics and Econometrics, 26(6), 43-51.
• Nel, H. (1996). The term structure of interest rates and economic activity in South Africa, “The South African Journal of Economics, 63(3), 161-74.
• Stojanovic, D. and Vaughan, M. (1997). Yielding clues about Recessions: The Yield Curve as a Forecasting Tool. Federal Reserve Bank of St. Louis.
• Watson, M. (1991). Using Econometric Models to Predict Recessions. Federal Reserve Bank of Chicago Economic Perspectives, 15, 14-25.
• Wright, J.H. (2006). The Yield Curve and Predicting Recessions. Board of Governors of the Federal Reserve System, Finance and Economics Discussion Series, no. 2006-07, February.
• Yield Curve as a Leading Indicator - Federal Reserve Bank of New York. Yield Curve as a Leading Indicator - Federal Reserve Bank of New York. N.p., n.d. Web. 03 June 2013.
• Bonser-Neal, C. and Morley, T. (1997). Does the yield spread predict real economic activity? Amulticountry analysis. Federal Reserve Bank of Kansas City Economic Review, 3rd Quarter, 37-53.
• Brunetti, M., and Torricelli, C., (2009). Economic activity and recession probabilities: information content and predictive power of the term spread in Italy. Applied Economics, 41, 2309- 2322.
• Butler, L. (1978). Recession? - A Market View. Federal Reserve Bank of San Francisco Weekly Letter, December 15.
• Dotsey, M. (1998). The predictive content of the interest rate term spread for future economic growth. Federal Reserve Bank of Richmond Economic Review, 3rd Quarter, 31-51.
• Erdogan, O., Bennett, P.B. and Ozyildirim, C. (2013). Predicting U.S. Recessions: Yield Curve and Stock Market Liquidity Deviation as Leading Indicators. 20th Annual Conference of the Multinational Finance Society, Turkey.
• Estrella, A. (2005). Why does the yield curve predict output and inflation? Economic Journal, 115, 722-744.
• Estrella, A. and Hardouvelis, G.A. (1991). The Term Structure as a Predictor of Real Economic Activity. Journal of Finance, 46(2), 555-76.
• Estrella, A. and Mishkin, F.S. (1997). Is there a role for monetary aggregates in the conduct of monetary policy? Journal of Monetary Economics, 40(2), 279-304.
• Estrella, A. and Mishkin, F.S. (1998). Predicting U.S. Recessions: Financial Variables As Leading Indicators. Review of Economics and Statistics, 80(1), 45-61.
• Federal Reserve Bank of Cleveland: Http://www.clevelandfed.org.” Yield Curve and Predicted GDP Growth. N.p., n.d. Web. 03 June 2013.
• Furlong, F.T. (1989). The Yield Curve and Recessions. Federal Reserve Bank of San Francisco Weekly Letter, March 10.
• Haubrich, J.G. and Dombrosky, A.M. (1996). Predicting real growth using the yield curve. Economic Review, 1996 Q1, 26-35.
• Khomo, M.M., and Aziakpono, M.M. (2007). Forecasting recessions in South Africa: a comparison of the yield curve and other economic indicators. South African Journal of Economics, 75(2), 194-212.
• Kim, C.J. and Nelson, C.R. (1999). Has the U.S. Economy Become More Stable? A Bayesian Approach Based on a Markov-Switching Model of the Business Cycle. Review of Economics and Statistics, 81(4), 608-16.
• Mohapi, T.A. and Botha, I. (2013). The explanatory power of the yield curve in predicting recessions in South Africa. International Business and Economics Research Journal, 12(6), 613-634.
• Moneta, F. (2005). Does the yield spread predict recessions in the Euro Area? International Finance, 8(2), 263-301.
• Moolman, E. (2002). The term structure as a predictor of recessions. Journal for Studies in Economics and Econometrics, 26(6), 43-51.
• Nel, H. (1996). The term structure of interest rates and economic activity in South Africa, “The South African Journal of Economics, 63(3), 161-74.
• Stojanovic, D. and Vaughan, M. (1997). Yielding clues about Recessions: The Yield Curve as a Forecasting Tool. Federal Reserve Bank of St. Louis.
• Watson, M. (1991). Using Econometric Models to Predict Recessions. Federal Reserve Bank of Chicago Economic Perspectives, 15, 14-25.
• Wright, J.H. (2006). The Yield Curve and Predicting Recessions. Board of Governors of the Federal Reserve System, Finance and Economics Discussion Series, no. 2006-07, February.
• Yield Curve as a Leading Indicator - Federal Reserve Bank of New York. Yield Curve as a Leading Indicator - Federal Reserve Bank of New York. N.p., n.d. Web. 03 June 2013.
How to Cite
Heath, Ellis. 2014. “The Inverted Yield Curve and the Components of GDP”. Studies in Business and Economics 17 (1). https://doi.org/10.29117/sbe.2014.0076.
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