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Yield Curve Inversion and the Incidence of Recession: A Dynamic IS-LM Model with Term Structure of Interest Rates

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  • X. Wang
  • Bill Yang

Abstract

This paper attempts to explain why yield curve inversion may serve as a leading indicator of recessions. It employs an IS-LM model with the term structure of interest rates and provides a formal phase-diagram analysis of dynamic adjustment process. It demonstrates that the occurrence of yield curve inversion is an off-equilibrium phenomenon after an adverse shock in the adjustment process of interest rates and output, and that an inverted yield curve may lead, but does not lead to, a recession. Copyright International Atlantic Economic Society 2012

Suggested Citation

  • X. Wang & Bill Yang, 2012. "Yield Curve Inversion and the Incidence of Recession: A Dynamic IS-LM Model with Term Structure of Interest Rates," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 18(2), pages 177-185, May.
    • Handle: RePEc:kap:iaecre:v:18:y:2012:i:2:p:177-185:10.1007/s11294-012-9350-7
    DOI: 10.1007/s11294-012-9350-7
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    References listed on IDEAS

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    1. Fisher, Walter H & Turnovsky, Stephen J, 1992. "Fiscal Policy and the Term Structure of Interest Rates: An Intertemporal Optimizing Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 24(1), pages 1-26, February.
    2. Arturo Estrella, 2005. "Why Does the Yield Curve Predict Output and Inflation?," Economic Journal, Royal Economic Society, vol. 115(505), pages 722-744, July.
    3. Keith M. Carlson & Roger W. Spencer, 1975. "Crowding out and its critics," Review, Federal Reserve Bank of St. Louis, vol. 57(Dec), pages 2-17.
    4. Estrella, Arturo & Hardouvelis, Gikas A, 1991. "The Term Structure as a Predictor of Real Economic Activity," Journal of Finance, American Finance Association, vol. 46(2), pages 555-576, June.
    5. Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022834, April.
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    More about this item

    Keywords

    Yield curve inversion; Recession; The IS-LM model; Term structure of interest rates; Phase diagram; E00; E30; E40;
    All these keywords.

    JEL classification:

    • E00 - Macroeconomics and Monetary Economics - - General - - - General
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General

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