Yield Curve as a Predictor of a Recession. Evidence from the US Economy.

Abstract

In this article, we are testing the effects of an inverted Yield curve, as a result of the relationship between the short and long-term interest rates of the US Treasury with constant maturities. Our aim is to illustrate and spot cycles that created the US recession in 2008 based on Estrella and Mishkin, (1996), spread definition. In our model, the recession probability is calculated by using a 99% confidence level of the standard normal cumulative distribution function. Then, we will apply a probit model to measure the relationship between a binary variable strength such as prediction of a recession over a number of other variables such as the logarithmic monthly returns of the Federal funds effective rates, and the logarithmic monthly returns of the seasonally adjusted money supply, (M2). The data that we have used are monthly returns starting from 01/10/1993 to 01/01/2013, which total to 231 observations. The data was obtained from the Federal Reserve Statistical Release Department and the symbols of the series are H.6, and H.15.