How does yield curve predict GDP growth? A macro-finance approach revisited

Abstract

This article analyses the yield-curve predictability for Gross Domestic Product (GDP) growth by modifying the time-series property of the interest rate process in Ang et al. (2006). When interest rates have a unit root and term spreads are stationary, the short rate's forecasting role changes, and the relationship between the shift of yield curves and GDP growth is intuitively revealed.

Keywords:

• yield curve
• GDP growth
• unit root
• estimation

JEL Classification:

• C13
• E43
• E44

Acknowledgements

I thank the seminar participants at the Bank of Japan, Keio University and the University of Tokyo for their useful discussions. I acknowledge the funding from the Nomura Foundation for Academic Promotion.

Notes

¹ A unit-root process could induce disputable long-run implications, for example, forward rates fall without limit as maturity increases. Thus, I limit my analysis to bond yield data up to a 5-year maturity.

² For the SEs under the constrained maximization, I calculated consistent estimates of the asymptotic variance discussed in Equation (7.4.22) in Hayashi (2000).

³ is the unconditional variance of   with , and is given by with .