The small open macroeconomy and the yield curve: A state-space representation |
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| Institution: | 1. IPAG Lab, IPAG Business School;2. European University Institute (EUI);3. Athens University of Economics and Business (AUEB);1. Structural Glycobiology Team, Systems Glycobiology Research Group, RIKEN-Max Planck Joint Research Center for Systems Chemical Biology, RIKEN Global Research Cluster, Wako, Saitama 351-0198, Japan;2. Department of Chemistry, Graduate School of Science, Osaka University, 1-1 Machikaneyama, Toyonaka, Osaka 560-0043, Japan;3. Disease Glycomics Team, Systems Glycobiology Research Group, RIKEN-Max Planck Joint Research Center for Systems Chemical Biology, RIKEN Global Research Cluster, Wako, Saitama 351-0198, Japan;1. Department of Economics and Quantitative Methods, Westminster Business School, University of Westminster, London NW1 5LS, UK;2. Department of Economics and IME, University of Salamanca, Salamanca, Spain;1. College of Chemistry and Chemical Engineering, Shanxi University, Taiyuan, Shanxi 030006, PR China;2. China Research Institute of Daily Chemical Industry, Taiyuan, Shanxi 030001, PR China;1. Department of Finance and Insurance, Miller College of Business, Ball State University, Muncie, IN 47306, United States;2. Department of Accounting, University of St. Thomas, St. Paul, MN 55105, United States |
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| Abstract: | This study extends a state-space representation of the yield curve and the macroeconomy to a small open economy in order to study the dynamic interaction between the yield curves in Canada and the U.S. The framework treats the U.S. term structure of interest rates as being exogenous to both the Canadian yield curve and macroeconomy. The empirical results support very strong links between the yield curves in the two countries, with the U.S. yield curve accounting for as much as 45 per cent of the variation of the movement in the level and about 30 per cent of the movements in the slope and the curvature of the Canadian yield curve. Canadian yield-curve factors are found to account for about 50 per cent of the variation in output and the monetary policy rate, and about 25 per cent of the variation in inflation, much larger than the yield curve effects found for future developments of the macroeconomies of other countries. A relatively strong bilateral relationship is found to exist between the yield curve and the instrument of monetary policy, supporting recent studies that find the dynamic relationship between the yield curve and the macroeconomy is due to the pivotal role that monetary policy plays in the macroeconomy. |
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| Keywords: | Yield curve Small open economy Factor model State-space model |
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