It's well known that in the United States recessions are often preceded by an inversion of the yield curve. Is there any economic rationale for this?
David Andolfatto, Andrew Spewak
Federal Reserve Bank of St. Louis, Economic Synopses, No. 30, 2018
A very interesting paper from the Federal Reserve Bank of St. Louis.
"Most yield curve analysis refers to nominal interest rates. Economic theory, however, stresses the relevance of real (inflation-adjusted) interest rates."
"An inverted yield curve doesn’t forecast recession; it forecasts conditions that make recession more likely."
"Consistent with the theory, consumption growth tends to decelerate as the yield curve flattens. This is true even in non-recessionary episodes. In particular, the consumption growth decelerations of 1985-86, 1988-89, and 2006-07 were each associated with or preceded by a flattening or inverted yield curve. Each of the three recessions occurred when consumption was growing at a moderate to low pace."
"Does the recent flattening of the yield curve portend recession? Not necessarily. The flattening of the real yield curve may simply reflect the fact that real consumption growth is not expected to accelerate or decelerate from the present growth rate of about 1 percent year over year."
Link to the full text