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Yield curve and the business cycle in conventional times

Author

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  • Roman Sustek

    (Queen Mary University of London
    Centre for Macroeconomics (CFM))

Abstract

A parsimonious model offers an interpretation of lead-lag cyclical dynamics of the yield curve. Low levels of nominal interest rates and inflation, but a steeper yield curve, observed typically ahead of an expansion reflect news about higher future output growth. If investors use bond markets mainly to hedge risk, the news is only weakly transmitted into real interest rates, but a Taylor rule transmits it into lower inflation. A steeper yield curve reflects higher risk premia when the positive news is accompanied by elevated uncertainty about the future growth path. The mechanism conforms with other important term structure moments.

Suggested Citation

  • Roman Sustek, 2021. "Yield curve and the business cycle in conventional times," Discussion Papers 2122, Centre for Macroeconomics (CFM).
    • Handle: RePEc:cfm:wpaper:2122
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    More about this item

    Keywords

    Term structure of interest rates; business cycle; recursive preferences; stochastic volatility;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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