Yield Curve and the Business Cycle in Conventionaltimes

A parsimonious model offers an interpretation of lead-lag cyclical dynamics of the yieldcurve. Low levels of nominal interest rates and inflation, but a steeper yield curve, observedtypically ahead of an expansion reflect news about higher future output growth. If investorsuse bond markets mainly to hedge risk, the news is only weakly transmitted into real interestrates, but a Taylor rule transmits it into lower inflation. A steeper yield curve reflects higherrisk premia when the positive news is accompanied by elevated uncertainty about the futuregrowth path. The mechanism conforms with other important term structure moments