Assessing Economic Activities by Using Term Spreads

Abstract

Both linear and non-linear models have been used in literature in developed countries to assess the forecasting power of the term spread on output. When it comes to developing economies, however, a gap in research exists. As such, the main objective of this research work is to assess the predicting capacity of the variable term spread on economic growth in the context of a developing country, namely, Mauritius. In this regard, an extended production function is designed that includes major relevant macroeconomic variables such as Spread, Investment, Human Capital, Openness to Trade, Foreign Direct Investment, and Inflation. Following the test of stationarity, where a mixture of I(0) and I(1) variables are obtained but no I(2), the autoregressive distributed lag (ARDL) model is chosen for regression purposes. We found that the spread variable has a positive impact on economic growth though being weakly significant and very low. A major limitation when dealing with Treasury Bills in Mauritius is the lack of data on medium to long-term securities, hence, restricting the longest term security use to the 1-year Treasury Bills. This research can be viewed as a pioneering work in assessing term spread on economic activity in developing economies.