Monetary Policy, Inflation Outlook, and Recession Probabilities
19 Pages Posted: 13 Jul 2022
Date Written: July 7, 2022
Why does the short-term slope of the yield curve predict recessions? We explore the economic forces underlying Treasury yields’ fluctuations and highlight the roles of a tight monetary policy stance and expectations of lower inflation in predicting downturns. While the monetary policy stance is still accommodative, indicating a low recession probability, the negative inflation slope points to higher odds of a recession within a year. An aggressive removal of policy accommodation increases the recession probability to 60%.
Keywords: yield-curve slope, recession forecasts, monetary policy, bond risk premia, policy path, inflation forecasts, near-term forward spread
JEL Classification: G10, G12, E32, E37, E44, E52
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