Dynamic Responses of Real Output to Financial Spreads

28 Pages Posted: 19 Jun 2017 Last revised: 15 Mar 2021

See all articles by Yu-Fan Huang

Yu-Fan Huang

Capital University of Economics and Business, ISEM

Date Written: Feburary 27, 2017

Abstract

This paper investigates how the term spread and the credit spread affect real output in the long-run. Predictive regression estimates imply that high term spreads signal long-lasting increases in output, while high credit spreads signal brief economic contraction. However, an impulse response analysis indicates that a positive shock in the credit spread leads to higher term spreads possibly due to monetary policy reactions. This interaction between term and credit spreads may lead to the inability of the credit spread to signal long-lasting changes in output. I thus specify a Vector Autoregression model and conduct a counterfactual analysis, which shuts down the interaction between spreads. The results using US data are summarized as follows: (i) a positive term spread shock, due to a TFP news shock, rises real output permanently; (ii) without the induced changes in the term spread, a positive credit spread shock causes the trend output to decline because of tight credit supply condition.

Keywords: Credit Spread; Term Spread; Trend Output; TFP News; Credit Supply.

JEL Classification: C32, E32, E44.

Suggested Citation

Huang, Yu-Fan, Dynamic Responses of Real Output to Financial Spreads (Feburary 27, 2017). International Review of Economics & Finance, Vol. 62, 2019, Available at SSRN: https://ssrn.com/abstract=2988279 or http://dx.doi.org/10.2139/ssrn.2988279

Yu-Fan Huang (Contact Author)

Capital University of Economics and Business, ISEM ( email )

Beijing, 100070
China

HOME PAGE: http://sites.google.com/site/yufaneconnerd/home

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