The Centre Matters for the Periphery of Europe: The Predictive Ability of a GZ-Type Spread for Economic Activity in Europe

This paper examines whether information from bond markets provides a reliable signal for future economic activity in Europe. It evaluates the marginal predictive content and economic significance of a risk-adjusted yield credit spread in five European countries from the early 1990s to the recent past. The inclusion of this bond yield spread improves markedly the goodness of fit of the forecasting equation for economic activity in countries on the European periphery. The within-sample forecasting ability of the GZ-spread is remarkable, both over the whole sample period and a sub-sample period marking the effective beginning of the Economic and Monetary Union of Europe in 1999. Its effect on economic activity is felt particularly during the 2007-12 Crisis period.