Inflation Changes, Yield Spreads, and Threshold Effects

Using interest rate yield spreads to explain changes in inflation, we investigate whether such relationships can be modelled using two-regime threshold models. Implementing a robust test to detect evidence of a threshold, we find that the hypothesis of linearity is generally rejected. For the United States, we find that the inflation-spread relationship at most horizons is more pronounced when the yield curve is inverted, which is usually associated with periods of tight monetary policy. This implies that monetary policy may have an asymmetric effect on inflation. Curiously, the pattern of asymmetry in Canada appears to operate in the opposite direction, with expansionary policies having a relatively greater impact on inflation than tighter policies.

Published In:

International Review of Economics and Finance (1059-0560)
2004. Vol. 13, Iss. 2, pp. 187-99