Scandinavian Working Papers in Economics

Research Papers in Economics,
Stockholm University, Department of Economics

No 2006:5: Does the Yield Spread Predict the Output Gap in the U.S.?

Paolo Zagaglia ()
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Paolo Zagaglia: Dept. of Economics, Stockholm University, Postal: Department of Economics, Stockholm University, S-106 91 Stockholm, Sweden

Abstract: Yes, but only at short horizons from 1 to 3 quarters over the full post-World War II sample. The predictive relation between the yield spread and the output gap is characterized by parameter instability. Differently from the predictive models of the yield spread for output growth, structural instability is not due to a loss of predictive ability after 1985. Rather, the predictive relation estimated on post-1985 data holds for a range of horizons larger than for pre-1985 data. I also show that the information on current monetary policy is statistically irrelevant for the prediction of the output gap over the post-1985 subsample.

Keywords: output gap; yield spread; predictability

JEL-codes: E27; E43

17 pages, May 8, 2006

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