The yield curve as a predictor and emerging economies

Abstract

This paper investigates the extent to which the slope of the yield curve in emerging economies predicts domestic inflation and growth. It also examines international financial linkages and how the US and euro area yield curves help to predict.It finds that the domestic yield curve in emerging economies contains in-sample information even after controlling for inflation and growth persistence, at both short and long forecast horizons, and that it often improves out-of-sample forecasting performance.Differences across countries are seemingly linked to market liquidity.The paper further finds that the US and euro area yield curves also contain in- and out-of-sample information for future inflation and growth in emerging economies.In particular, for emerging economies with exchange rates pegged to the US dollar, the US yield curve is often found to be a better predictor than the domestic curves and to causally explain their movements.This suggests that monetary policy changes and short-term interest rate pass-through are key drivers of international financial linkages through movements at the low end of the yield curve.Key words: emerging economies, yield curve, forecasting, international linkages JEL classification number: E44, F3, C5