The Predictive power of the yield curve: evidence from Spain

Abstract

The slope of the yield curve has been mentioned as a leading economic indicator of the economy’s path in the future. Thus, an inversion of the curve has been interpreted as a sign of a future recession. Over the last decades, empirical research has been made with the aim of finding a significant relationship between the yield curve and future economic activity. In this paper, we examine the predictive power of the yield curve in Spain. We consider a simple linear regression model which predicts the change in the industrial production using the yield spread as an explanatory variable. To study the stability of recession forecasts over time, we divided the full dataset in two sub-samples. Moreover, as the literature states that binary models are more stable at forecasting future economic activity, we consider a probit model to predict recessions using the yield curve. Results obtained in both models are not statistically significant at any conventional significance level.