Why Does the Yield-Curve Slope Predict Recessions?

Luca Benzoni, Olena Chyruk and David Kelley

No WP-2018-15, Working Paper Series from Federal Reserve Bank of Chicago

Abstract: Why is an inverted yield-curve slope such a powerful predictor of future recessions? We show that a decomposition of the yield curve slope into its expectations and risk premia components helps disentangle the channels that connect fluctuations in Treasury rates and the future state of the economy. In particular, a change in the yield curve slope due to a monetary policy easing, measured by the current real-interest rate level and its expected path, is associated with an increase in the probability of a future recession within the next year. In contrast, a decrease in risk premia is associated with either a higher or lower recession probability, depending on the source of the decline. In recent years, a decrease in the inflation risk premium slope has been accompanied by a heightened risk of recession, while a lower real-rate risk premium slope is a signal of diminished recession probabilities. This means that not all declines in the yield curve slope are bad news for the economy, and not all instances of steepening are good news either.

Keywords: Interest rates; yield-curve slope; recession forecasts; monetary policy; bond risk premia; policy path (search for similar items in EconPapers)
JEL-codes: E32 E37 E44 E52 G10 G12 (search for similar items in EconPapers)
Pages: 17 pages
Date: 2018-09-28
New Economics Papers: this item is included in nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Journal Article: Why Does the Yield-Curve Slope Predict Recessions? (2018)
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DOI: 10.21033/wp-2018-15

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