Predicting Recessions Using the Yield Curve: The Role of the Stance of Monetary Policy

Abstract: The yield curve is often viewed as a leading indicator of recessions. While the yield curve’s predictive power is not without controversy, its ability to anticipate economic downturns endures across specifications and time periods. This note examines the predictive power of the yield curve after accounting for the current stance of monetary policy—a relevant issue given that monetary policy was unusually accommodative during the most recent yield curve inversion, in the third quarter of 2019. The results show that a yield curve inversion likely overstates the probability of a recession when the stance of monetary policy, judged relative to a time-varying neutral federal funds rate, is accommodative.

Keywords: term spread; yield curve inversion; recession probabilities;

JEL Classification: E43; E44;

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Bibliographic Information

Provider: Federal Reserve Bank of Boston

Part of Series: Current Policy Perspectives

Publication Date: 2020-02-03