The yield curve strikes back: New evidence of its predictive power for economic activity and inflation

Abstract

In this paper, we investigate the informational content of the yield curve for future economic activity and inflation across 40 countries over 2010–2021. We examine developed, Central and Eastern European (CEE),and emerging markets, grouping countries based on their monetary policy credibility and economic stability. First, we extract unobservable yield curve factors (level, slope, and curvature) for each country from its sovereign curve. We then incorporate the estimated slope and curvature into predictive regressions for economic growth and inflation using panel regressions. Finally, as a key innovation, we evaluate the out-of-sample forecasting accuracy of slope and curvature using novel panel forecasting techniques and econometric tests. Our empirical results show that slope and curvature contain predictive power for economic growth in CEE and developed countries. In emerging markets, yield curve factors shape expectations about future growth and inflation, but their out-of-sample forecasting performance remains limited. We further find that the strength of these predictive relationships depends critically on monetary policy credibility, with slope and curvature being more informative for future growth in countries where monetary policy credibility is lower. By contrast, economic stability does not materially affect forecasting performance. Finally, yield curve factors provide only limited and unstable signals for forecasting inflation.