The Use of the Yield Curve as a Leading Indicator

There has been much discussion of using the yield curve as a leading indicator. Arturo Estrella, Senior Vice President in the Research and Statistics Group at the Federal Reserve Bank of New York, reviews the evidence on the use of the yield curve as a leading indicator. The links are to the NY Fed site:

The Yield Curve as a Leading Indicator, by Arturo Estrella, NY Fed: A broad literature originating in the late 1980s documents the empirical regularity that the slope of the yield curve is a reliable predictor of future real economic activity. Today, there exists a substantial body of evidence from which various useful stylized facts have emerged. This catalogue of some of the salient findings takes the form of answers to frequently asked questions. An extensive bibliography is also included. [FAQ Available in PDF] [Bibliography]

Frequently Asked Questions: Click on a question from the following list to go to the corresponding answer.

• What does the evidence say, in short?
• How and when were the relationships first identified?
• How long have these relationships existed, and do they still hold?
• Are formal models needed to extract the information content in the yield curve, or are there also rules of thumb?
• What statistical models have been formulated?
• Which interest rates to use: Treasuries, fed funds, Eurodollar, swap, corporate?
• What maturity combinations work best?
• Is it the level or the change in the spread that matters?
• Does it matter if changes are driven by the short or the long end?
• Is an inversion required for a signal?
• Does the signal have to be persistent?
• Is the evidence robust over time?
• How do binary models that predict recessions compare with models that forecast continuous dependent variables (e.g., real GDP, industrial production growth)?
• How does the yield curve compare with other indicators?
• How does the yield curve perform out of sample, and can it be supplemented with other indicators?
• How are predictions related to monetary policy?
• How are predictions related to market expectations of the economy?
• Is there causality from economic activity to the yield curve?
• Should we expect the predictive power of the term spread for real activity to persist?