Yield Curve Inversion and the Incidence of Recession: A Dynamic IS-LM Model with Term Structure of Interest Rates |
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Authors: | X. Henry Wang Bill Z. Yang |
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Affiliation: | 1. Department of Economics, University of Missouri-Columbia, Columbia, MO, USA 2. Department of Finance and Economics, Georgia Southern University, Statesboro, GA, USA
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Abstract: | This paper attempts to explain why yield curve inversion may serve as a leading indicator of recessions. It employs an IS-LM model with the term structure of interest rates and provides a formal phase-diagram analysis of dynamic adjustment process. It demonstrates that the occurrence of yield curve inversion is an off-equilibrium phenomenon after an adverse shock in the adjustment process of interest rates and output, and that an inverted yield curve may lead, but does not lead to, a recession. |
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