Weekend Reading: Claire Berlinski: Post-WWII Western Europe

Ryan Avent: Bond yields reliably predict recessions. Why?: "An inverted yield curve may mean a few things, none of them cheering...

...Just before each of America’s most recent three recessions the yield curve for government bonds “inverted”, meaning that yields on long-term bonds fell below those on short-term bonds.... Markets may expect future short-term rates to be lower than present ones, presumably because the central bank has chosen to cut rates in response to economic weakness. Or markets may think they need less compensation for holding long-term bonds in the future. That might reflect expectations that inflation will fall, or that appetite will grow for the safety provided in financial storms by long-run government debt. More generally, the yield curve often inverts when a central bank is expected to switch from a bout of monetary tightening to one of monetary easing. Such transitions often happen around the time a boom comes to an end and a recession begins....

There is also something strange about the enduring power of the yield-curve indicator. A reliable signal that a recession looms should prod central banks into preventive action. That should help avert recession, thereby destroying the predictive power of the indicator.... Or perhaps not. In 2006 Ben Bernanke, then the chairman of the Federal Reserve, expressed scepticism about the danger indicated by the yield curve, noting that he “would not interpret the currently very flat yield curve as indicating a significant economic slowdown to come”. (It did.) When asked about the flattening yield curve in March of this year, Jerome Powell, the current chairman, echoed Mr Bernanke’s sentiment, saying: “I don’t think that recession probabilities are particularly high at the moment, any higher than they normally are.” Awkwardly, whether Mr Powell is right or not depends on how his Fed plans to react to the yield-curve signal...


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