Friday, October 2, 2009

Great Survey Paper on the Predictive Ability of the Term Spread

There is new paper by David Wheelock and Mark Wohar of the St. Louis Fed that surveys the literature on the relationship between the Treasury yield curve spread and future economic activity:
Can the Term Spread Predict Output Growth and Recessions? A Survey of the Literature
This article surveys recent research on the usefulness of the term spread (i.e., the difference between the yields on long-term and short-term Treasury securities) for predicting changes in economic activity. Most studies use linear regression techniques to forecast changes in output or dichotomous choice models to forecast recessions. Others use time-varying parameter models, such as Markov-switching models and smooth transition models, to account for structural changes or other nonlinearities. Many studies find that the term spread predicts output growth and recessions up to one year in advance, but several also find its usefulness varies across countries and over time. In particular, many studies find that the ability of the term spread to forecast output growth has diminished in recent years, although it remains a reliable predictor of recessions.

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