Predicting Output and Inflation in Less Developed Financial Markets Using the Yield Curve: Evidence from Malaysia

This paper investigates the role of the term spread to predict domestic output and inflation in less developed financial market with the focus on Malaysia bond market. By controlling for past values of the dependent variable, this paper finds that the term spread of various bond maturities contain relevant information about future output and inflation at short horizons. Besides that, we employ a probit model to assess the ability for the yield curve to predict future economic slowdown. The results suggest that the term spread has contributed significantly in the probability of predicting future economic slowdown. Despite the under-developed bond market, the findings point to the potential for bond yields to play a greater role in monetary analysis beyond conventional indicators. From the policy point of views, the results from our analysis suggest that there is a significant potential for incorporating more technical and model based approaches using the yield curve beyond the usual indicator analysis.