Future Output Growth Research Articles

The decline in the predictive power of the US term spread: A structural interpretation

Numerous studies have found the term spread to be a significant predictor of future real output growth. However, in the case of the US, the term spread’s predictive power has diminished from the mid-1980s till present. This paper provides new evidence to the debate on why the term spread leads output growth. We do this by structurally accounting for the decline in the predictive power of the US term spread. Our findings indicate that it is changes to the composition of shocks hitting the US economy which has caused the term spread, through the endogenous monetary policy response, to be a less reliable indicator of future output growth in recent decades.

The predictive content of the term premium for GDP growth in Canada: Evidence from linear, Markov-switching and probit estimations

The objective of this study is to assess the predictive content of the term premium for future GDP growth in Canada over the past 55 years. The term premia for average long-term bond yields for four maturity categories are derived using the stationary vector-stochastic process for the expectation hypothesis of Campbell and Shiller (1987, 1991). The bivariate VAR model identifies term premia for the bond yields that are mean-stationary and increase on average to about 100 basis points. The coefficients on the expectations components of the term spreads in linear estimations are found to be equal to those on the term premium components for all maturity categories, suggesting that there is no addition information about future GDP growth in the term premium components. However, regime-switching estimations that stochastically divide the sample period into high- and low-variance regimes indicate that the equality of the coefficients on both components of the term spreads can easily be rejected for all maturities in both regimes. The expectations component is found to be more important than the term premium component when future output growth is volatile, while it is not found to be important during ‘normal times’ when the variability of GDP growth is relatively low. Probit model estimations suggest that the expectations component of the term spread (removing the term premium component) produce relatively more reliable predictions of future recessions than the term premium component, which has only marginal information for predicting future recessions.

The Information Content of Stock Market Factors

This paper examines the information content within several popular stock market factors, asking whether they contain independent explanatory power for stock returns and whether their movements relate to economic variables. Given, the explosion in the number of such factors, it is important to consider whether each factor adds to our understanding of markets and the wider economy. We undertake three related exercises, whether a set of common factors contain independent predictive ability for stock return portfolios, what economic and market variables can explain movements in the factors and whether stock market factors have predictive power for future output growth. The results support the view that several of the considered factors do not contain independent information for stock returns. Further, most of these factors do not provide any predictive power for future output growth and thus appear not to contain any economic content or information regarding economic behaviour. Evidence suggest that movement in the factors is driven by considerations of current economic and market risk. Hence, stock market factors reflect existing economic conditions but do not provide a window on future behaviour.

Model and survey estimates of the term structure of US macroeconomic uncertainty

Survey data on macro-forecasters suggest that their assessments of future output growth and inflation uncertainty tend to be too high. We find that model estimates of the term structure of ex ante or perceived macro uncertainty are more in line with ex post RMSE measures than are the survey respondents’ perceptions. At shorter horizons, the models’ assessments of the uncertainty characterising the outlook are lower than those indicated by the survey data histograms, and closer to the RMSE estimates. Recent developments in econometric modelling ensure that the models’ information sets line up with the timing of information available to the survey respondents, thus enabling a fair comparison.

Intuitive and Reliable Estimates of the Output Gap from a Beveridge-Nelson Filter

The Beveridge-Nelson (BN) trend-cycle decomposition based on autoregressive forecasting models of U.S. quarterly real GDP growth produces estimates of the output gap that are strongly at odds with widely-held beliefs about the amplitude, persistence, and even sign of transitory movements in economic activity. These antithetical attributes are related to the autoregressive coefficient estimates implying a very high signal-to-noise ratio in terms of the variance of trend shocks as a fraction of the overall quarterly forecast error variance. When we impose a lower signal-to-noise ratio, the resulting decomposition, which we label the BN produces a more intuitive estimate of the output gap that is large in amplitude, highly persistent, and typically positive in expansions and negative in recessions. Real-time estimates from the filter are also reliable in the sense that they are subject to smaller revisions and predict future output growth and inflation better than for other methods of trend-cycle decomposition that also impose a low signal-to-noise ratio, including deterministic detrending, the Hodrick-Prescott filter, and the bandpass filter.

Accounting for Debt Service: The Painful Legacy of Credit Booms

When taking on new debt, borrowers commit to a pre-specified path of future debt service. This implies a predictable lag between credit booms and peaks in debt service which, in a panel of household debt in 17 countries, is four years on average. The lag is driven by two key features of the data: (i) new borrowing is strongly auto-correlated and (ii) debt contracts are long term. The delayed increase in debt service following an impulse to new borrowing largely explains why credit booms are associated with lower future output growth and higher probability of crisis. This provides a systematic transmission channel whereby credit expansions can have adverse long-lasting real effects.

Trend-Cycle Decompositions of Real GDP Revisited: Classical and Bayesian Perspectives on an Unsolved Puzzle

While Perron and Wada (2009) show that postwar U.S. real GDP follows a trend stationary process (TSP) based on the maximum likelihood approach, our analysis based on the Bayesian approach shows that it is a difference stationary process (DSP) with the stochastic trend component explaining most of the variations in real GDP. One goal of this paper is to provide a comprehensive analysis on the sources of such different results and to suggest that more credibility should be conferred to the Bayesian inference. Another goal naturally is to re-investigate the trend-cycle decompositions within the Bayesian framework. This is done by employing a model that incorporates time variation in both the mean and variance. The Bayesian approach to model selection prefers a DSP model to a TSP model, even though the evidence is less than decisive. Empirical results also show that there exists convincing evidence that the cycle from the DSP model, which is small in magnitude and noisy, has out-of-sample predictive power for future output growth at short horizons. The highly persistent TSP cycle without any predictive power may be related to spurious periodicity discussed in Nelson and Kang (1981).

Is Business Cycle Asymmetry Intrinsic in Industrialized Economies?

We consider a model-averaged forecast-based estimate of the output gap to measure economic slack for ten industrialized economies. Our measure takes changes in the long-run growth rate into account and, by accounting for model uncertainty using equal weights on different forecast-based estimates, is robust to different assumptions about the underlying structure of the economy. For each country, we find that the estimated output gap is highly asymmetric, with much larger negative movements during recessions than positive movements in expansions, suggesting that this particular form of business cycle asymmetry is an intrinsic characteristic of industrialized economies. Furthermore, the estimated output gap is strongly negatively correlated with future output growth and unemployment and positively correlated with capacity utilization in each case. It also implies a convex Phillips Curve in many cases.

Fiscal austerity, growth prospects, and sovereign CDS spreads: The Eurozone and beyond

This paper applies both conventional panel data models and a dynamic simultaneous equations model to analyze the impact of fiscal austerity and growth prospects along with other macro fundamentals on the pricing of sovereign credit default swaps (CDS) for a panel of 36 countries including the Eurozone. We find that austerity practice generally leads to an expectation of improved fiscal situations, which tends to help the CDS market grow more confidence in indebted sovereigns׳ ability to service their debt. The public debt to GDP ratio and projected future output growth also play an important role in determining the prices of sovereign debt insurance. Our analyses further show that the behavior of CDS spreads is considerably affected by common time trends over the sample period.

In Search of Leading Indicator Property of Yield Spread for India: An Approach Based on Quantile and Wavelet Regression

The leading indicator ability of yield spread for future output growth and inflation is tested for India. Using the yields on securities with maturities ten years and three months to construct yield spread, we study the predictive power of yield spread for output growth and inflation. Our results based on regression of future inflation and output on yield spreads indicate that there is no information in the yield spread about future economic activity and inflation in India. Further, the predictive power of yield spread is analyzed over different quantiles of inflation and output growth using quantile regression; we find that there is again no evidence of predictive information in the yield spreads. Using multiscale wavelet based regression, predictive power is however unveiled at higher time scales for output growth only.

The role of FOMC minutes for US asset prices before and after the 2008 crisis: Evidence from GARCH volatility modeling

Abstract This study explores the impact on US asset prices of novel data from minutes released by the Federal Open Market Committee. With data from fixed income assets, the main exchange rates of the US dollar, a House Price Index and various GARCH modeling, the empirical findings document significant effects of those minutes on the mean and volatility of asset prices only before the 2008 crisis. After the crisis, these effects become weaker, which is possibly attributable to the stronger transparency of monetary policy decisions as well as the implementation of monetary policy that persistently leads interest rates close to the zero lower bound, where they carry a weaker informational content. The baseline results survive a number of robustness tests. In addition, the findings are expected to provide important insight for monetary policymakers and market participants as they provide significant information on how well decisions are anticipated by market participants and how they adjust their views about future monetary policy, output growth, and inflation.

Stock market volatility and international business cycle dynamics: Evidence from OECD economies

How does a surprise movement in stock market volatility affect our forecasts of future output across countries? This paper studies the time series and cross-sectional responses of output to variation in stock market volatility across 27 countries over 40 years, controlling for a number of country-specific characteristics. High levels of stock market volatility are detrimental to future output growth not only after financial crises as previously emphasized in the literature, but also in non-crisis periods. Output growth and interest rates react negatively to a random shock to volatility and revert to their means quickly thereafter. Moreover, these results are robust after controlling for economic policy uncertainty, the level of financial development, and the direction of the market.

Interest rate spreads and output: A time scale decomposition analysis using wavelets

The information content of several interest rate spreads for future output growth is analyzed using wavelet analysis. The “scale-by-scale” regression analysis shows that standard indicators of the stance of monetary policy, such as the shape of the yield curve, the real federal funds rate, and the credit spread have different information content for future output at different time frames. This is consistent with the idea that allowing for different time scales of variation in the data can provide a deeper understanding of the complex dynamics between real and financial variables, certainly richer than those obtainable using standard aggregate regression methods.

Uncertainty and Economic Activity

The 2007-2008 global financial crisis and the subsequent anemic recovery have rekindled academic interest in quantifying the impact of uncertainty on macroeconomic dynamics based on the premise that uncertainty causes economic activity to slow down and contract. In this paper, we study the interrelation between financial markets volatility and economic activity assuming that both variables are driven by the same set of unobserved common factors. We further assume that these common factors affect volatility and economic activity with a time lag of at least a quarter. Under these assumptions, we show analytically that volatility is forward looking and that the output equation of a typical VAR estimated in the literature is mis-specified as least squares estimates of this equation are inconsistent. Empirically, we document a statistically significant and economically sizable impact of future output growth on current volatility, and no effect of volatility shocks on business cycles, over and above those driven by the common factors. We interpret this evidence as suggesting that volatility is a symptom rather than a cause of economic instability.

Fiscal Austerity, Growth Prospects, and Sovereign CDS Spreads: The Eurozone and Beyond

This paper applies both conventional panel data models and a dynamic simultaneous equations model to analyze the impact of fiscal austerity and growth prospects along with other macro fundamentals on the pricing of sovereign credit default swaps (CDS) for a panel of 36 countries including the Eurozone. We find that austerity practice generally leads to an expectation of improved fiscal situations, which tends to help the CDS market grow more confidence in indebted sovereigns’ ability to service their debt. The public debt to GDP ratio and projected future output growth also play an important role in determining the prices of sovereign debt insurance. Our analyses further show that the behavior of CDS spreads is considerably affected by common time trends over the sample period.

The Oil Price-Macroeconomy Relationship: Does Persistence Matter?

The literature on the relationship between real output growth and the growth rate in the price of oil, including an allowance for asymmetry in the impact of oil prices on output, continues to evolve. Here we show that a new technique, which allows us to control for both this asymmetry and also for the persistence of oil price changes, yields results implying that such control is necessary for a statistically adequate specification of the relationship. The new technique also yields an estimated model for the relationship which is more economically interpretable. In particular, using quarterly data from 1976 - 2007 on each of six countries which are essentially net oil importers, we find that changes in the growth rate of oil prices which persist for more than four years have a large and statistically significant impact on future output growth, whereas less persistent changes (lasting more than one year but less than four years) have no significant impact on output growth. In contrast, 'temporary' fluctuations in the oil price growth rate - persisting for only a year or less - again have a large and statistically significant impact on output growth for most of these countries. The results for the single major net oil producer in our sample (Norway) are distinct in an interesting way.

Predicting output using the entire yield curve

Many papers find that the term spread of the term structure of government bond yields can predict future output growth. This paper extends that literature by exploiting information in the entire term structure of interest rates. I apply a dynamic version of the Nelson–Siegel yield curve model to jointly model real GDP growth and yield factors. I find that the dynamic yield curve model produces better out-of-sample forecasts of real GDP than those generated by the traditional term spread model. The main source of this improvement is in the dynamic approach to constructing forecasts versus the direct forecasting approach used in the term spread model. While I confirm the importance of the term spread as a predictor of future output, there is also a gain from using information in the curvature factor.

Have structural changes eliminated the out-of-sample ability of financial variables to forecast real activity after the mid-1980s? Evidence from the Canadian economy

This article evaluates how consistently reliable the information content of individual financial variables is for Canada's future output growth. We estimate the timing of structural changes in linear growth models and check robustness to specification changes, multiple breaks, and business cycle asymmetry. Our simulated out-of-sample forecast evaluation strategy, using the Mean Square Error F-type (MSE-F) and the new encompassing (ENC-NEW) tests, shows that the leading information content of most financial variables for Canada's future Gross Domestic Product (GDP) growth has deteriorated substantially after 1984:04, but the 1–3-year term spread exhibits a consistently reliable predictive ability at the 1 and 2 quarter horizons and has significant forecasting ability at the 8 quarter horizon. Also, the real M1 money growth has regained its ability to forecast output growth since 1991:01.

The impact of banking sector stability on the real economy

This article studies the relationship between the degree of banking sector stability and the subsequent evolution of real output growth and inflation. Adopting a panel VAR methodology for a sample of 18 OECD countries, we find a positive link between banking sector stability and real output growth. This finding is predominantly driven by periods of instability rather than by very stable periods. In addition, we show that an unstable banking sector increases uncertainty about future output growth. No clear link between banking sector stability and inflation seems to exist. We then argue that the link between banking stability and real output growth can be used to improve output growth forecasts. Using Fed forecast errors, we show that banking sector stability (instability) results in a significant underestimation (overestimation) of GDP growth in the subsequent quarters.

Fiscal policy, pricing frictions and monetary accommodation

This paper empirically investigates whether the theoretical conditions for government expenditure expansions to be effective, hold for the data. We ask whether the necessary conditions for fiscal effectiveness are relevant on average, and in special circumstances that capture features of the recent crisis. Fiscal policy can be an effective countercyclical tool if monetary policy accommodates the fiscal expansion, if expectations about future output growth and inflation are constant, and if structural relationships are invariant to the policy change. Recent expansions are unlikely to produce large output multipliers or have important debt or inflation effects. Credible deficit and debt reduction schemes can produce sizeable output multipliers. — Fabio Canova and Evi Pappa