Yield spreads and real economic activity in East European transition economies

Abstract

Recent research in developed countries provides evidence for the significant role of the yield spread on real economic activity. Using k-months industrial production growth rate model, this article attempts to ascertain whether similar results are obtained for countries from East Europe (Czech Republic, Poland, Hungary and Slovakia). The results suggest that the interest rate spread does indeed have some predictive power over the 24-months across the countries. These results remain qualitative robust to the inclusion of additional variables and to the change of unemployment rate as a different measure of economic activity. Cyclical movements of volatility appear to be unable to account for the usefulness of the spread for forecasting industrial production growth. Finally, it is found that the term spread is a better indicator of future real growth in countries with low and stable inflation (Czech Republic) and not in countries characterized by high and volatile inflation (Hungary).

Notes

¹ Laurent (1988, 1989), Stock and Watson (1989), Estrella and Hardouvelis (1991).

² Fed also announced in June 2005 that it would adjust its procedures so as to focus on the level of the spread and not the change.

³ Harvey (1991), Lowe (1992), Cozier and Tkacz (1994), Bouser-Neal and Morley (1997), Estrella and Mishkin (1997), Funke (1997),Bernard and Gerloch (1998).

⁴ These are countries with economies in transition from the old communist empire dominated by the Soviet Union until the early 1990s.

⁵ Prague stock exchange 50 Index (CZ), Budapest stock index (HG), Wrasawzki Indeks Giedowy (POL), Slovak share index (SLOVAKIA). Data source: Eurostat.

⁶ Source: International Labour Organization, http://www.ilo.org/public/english/bureau/stat/index.htm, Bureau of Statistics.

⁷ The interest spread, k-month IPI growth, stock market indices returns, k-month change in unemployment rate.

⁸ For economy of space maximum likelihood estimators from the Exponential GARCH models are not presented but are available from author on any request.

⁹ Harvey (1989), Plosser and Rouwenhorst (1994), Bonser-Neal and Morley (1997).

Table 2. Term spreads as predictors of future real industrial production growth