GDP Trend Deviations and the Yield Spread: the Case of Five E.U. Countries

TL;DR

This study investigates how yield spreads and additional economic indicators can predict real economic activity across five European countries, revealing significant but varied forecasting power and policy implications.

Contribution

It introduces a comprehensive model combining yield spreads and non-monetary variables to forecast economic activity in multiple EU countries, highlighting cross-country differences.

Findings

Yield spreads plus non-monetary variables improve forecast accuracy.

Forecasting power varies significantly across countries.

Policy implications depend on country-specific economic dynamics.

Abstract

Several studies have established the predictive power of the yield curve in terms of real economic activity. In this paper we use data for a variety of E.U. countries: both EMU (Germany, France, Italy) and non-EMU members (Sweden and the U.K.). The data used range from 1991:Q1 to 2009:Q1. For each country, we extract the long run trend and the cyclical component of real economic activity, while the corresponding interbank interest rates of long and short term maturities are used for the calculation of the country specific yield spreads. We also augment the models tested with non monetary policy variables: the countries' unemployment rates and stock indices. The methodology employed in the effort to forecast real output, is a probit model of the inverse cumulative distribution function of the standard distribution, using several formal forecasting and goodness of fit evaluation tests. The results show that the yield curve augmented with the non-monetary variables has significant forecasting power in terms of real economic activity but the results differ qualitatively between the individual economies examined raising non-trivial policy implications.