Does the level of the yield curve predict inflation?

Abstract

This article addresses the issue of forecasting inflation using the term structure of interest rates. I use several measures for the level and the slope of the yield curve and investigate their predictive content for inflation. The results show that the forecasting performance of the indicators varies across countries. The findings suggest that the level of the yield curve is a better predictor for inflation than the slope of the yield curve.

Keywords:

• yield curve
• inflation
• forecasting

JEL Classification:

• C22
• E47

Notes

¹ For a survey on the predictive power of the yield spread on inflation, see Stock and Watson (2003).

² http://econ.jhu.edu/directory/jonathan-wright/

³ The test of Clark and McCracken (2001) is not used because the models are nested only if the same lag length for inflation is used in Equations 1 and 2.

⁴ Diebold and Li (2006) argue that an appropriate value for can be found if it is considered that determines the maturity at which the loading of the curvature factor, , reaches its maximum.

⁵ For 1- and 3-month forecast horizons, none of the indicators has additional predictive power.