TITLE:
Yield Curve and the Business Cycle in Conventional Times
AUTHORS:
Roman Šustek
KEYWORDS:
Term Structure of Interest Rates, Monetary Policy, Business Cycle, Recursive Preferences, Stochastic Volatility
JOURNAL NAME:
Journal of Mathematical Finance,
Vol.14 No.1,
February
27,
2024
ABSTRACT: This paper offers a structural interpretation of the “leading indicator” properties of the yield curve observed in
conventional times of monetary policy. Low levels of nominal interest rates and
inflation, but a steeper yield curve, typically precede economic expansions.
According to the model, if investors use bond markets mainly to hedge risk,
positive economic news are only weakly transmitted into real interest rates,
but monetary policy transmits them into lower inflation and nominal rates. A
steeper yield curve reflects both expected faster growth and higher uncertainty
about the growth path. Importantly, the mechanism conforms with other important
term structure properties.