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The High-Yield Spread as a Predictor of Real Economic Activity: Evidence of a Financial Accelerator for the United States
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@MISC{Mody_thehigh-yield,
author = {Ashoka Mody and Mark P. Taylor},
title = {The High-Yield Spread as a Predictor of Real Economic Activity: Evidence of a Financial Accelerator for the United States},
year = {}
}
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Abstract
Previous studies find that the interest rate term spread predicts real U.S. economic activity. We show that this relationship breaks down for the 1990s and suggest that its earlier success was due to high and volatile inflation. We find, however, that the high-yield spread (HYS) between “junk bond ” and government bond yields predicts real activity during the 1990s—especially high levels of the HYS. We also find that the HYS works through both the demand and the supply side of the economy. We interpret our findings as supportive of a financial accelerator mechanism. [JEL E33, E44] The slope of nominal yield curve, or the term spread, was shown by studies published in the late 1980s and early 1990s to have significant predictive content for future real economic activity, both in the United States and in Europe. 1 Following the early work by Stock and Watson (1989) and Estrella and Hardouvelis (1991), 2 however, confidence in the predictive power of the term spread waned a little when it failed to predict the 1990–91 U.S. recession (see, for example, Dotsey, 1998). Nevertheless, further work by, among others, Estrella and Mishkin (1997) and Plosser and Rouwenhorst (1994) seemed to establish that its power as a leading indicator of real economic activity had not evaporated. This somewhat mixed evidence on the forecasting performance of the term spread remains in the literature.
Keyphrases
high-yield spread real economic activity united state term spread financial accelerator jel e33 significant predictive content volatile inflation future real economic activity forecasting performance previous study predictive power government bond yield mixed evidence leading indicator late 1980s junk bond u.s. recession supply side early work high level nominal yield curve financial accelerator mechanism real activity
