The Term Structure as a Predictor of Recessions

Abstract

Despite the existence of macroeconomic models and complex business cycle indicators, policymakers and market participants can benefit by looking at a few well-chosen indicators such as the term structure of interest rates in predicting business cycle turning points. If the term structure accurately predicts business cycle turning points, it provides an easy way to confirm the predictions of macroeconomic models, or it can eliminate the need for a macroeconomic model the interest is in the turning points and not in the levels of the business cycle. The objective of this paper is to predict turning points of the South African business cycle based on its relationship with the term structure of interest rates. A probit model was used, and the results indicate that the term structure successfully predicts turning points of business cycle two quarters ahead. The negative empirical relationship between the term structure of interest rates and the business cycle conforms to economic theory.