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The Yield Spread as a Symmetric Predictor of Output and Inflation

Gikas Hardouvelis () and Dimitrios Malliaropoulos
Authors registered in the RePEc Author Service: Dimitrios Malliaropulos ()

No 4314, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We present evidence that the predictive ability of the yield spread for short-run inflation is related to its predictive ability for economic activity. In particular, an increase in the slope of the term structure predicts an increase in output growth and a decrease in inflation of equal magnitude. In order to explain this finding, we develop a monetary asset-pricing model with sticky goods prices. Sticky prices imply that economic disturbances generate predictable changes in output and inflation, thus allowing for intertemporal substitution effects and changes in the slope of the yield curve. We derive analytic solutions of the covariance between the nominal yield spread and future output growth and inflation and show that a moderate degree of price stickiness and relatively high degree of intertemporal substitution can account for the observed correlations in the US data over the period 1960:Q1 - 2003:Q2.

Keywords: general equilibrium; term structure of interest rates (search for similar items in EconPapers)
JEL-codes: E43 E44 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac and nep-mon
Date: 2004-03
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