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A Note on the (Continued) Ability of the Yield Curve to Forecast Economic Downturns in S outh A frica
Author(s) -
Botha Ferdi,
Keeton Gavin
Publication year - 2014
Publication title -
south african journal of economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.502
H-Index - 31
eISSN - 1813-6982
pISSN - 0038-2280
DOI - 10.1111/saje.12053
Subject(s) - economics , mistake , yield curve , interest rate , inflation (cosmology) , yield (engineering) , monetary economics , keynesian economics , bond , nominal interest rate , recession , monetary policy , real interest rate , law , finance , physics , materials science , theoretical physics , political science , metallurgy
In 2002‐2003, the S outh A frican yield spread falsely signalled a downswing that never materialised. This paper provides two reasons for this false signal. First, while the Reserve Bank never actually officially declared the start of a downswing, by alternative measures a downswing did actually occur. It is this severe weakness in economic activity at that time that the yield curve pointed to. Second, short‐term interest rates in 2003 were higher than they should have been because of a mistake made in measuring consumer price inflation. Because S outh A frica had recently introduced an inflation‐targeting regime, policy interest rates were, as a result of this error, kept too high for too long. This policy mistake was rectified as soon as the error in the C onsumer Price Index was discovered. Thus, the yield curve in 2003 pointed to the reality that short‐term interest rates were too high and risked pushing the economy into full blown recession. This is demonstrated by the fact that it was a fall in long bond interest rates that caused the yield spread to turn negative, indicating expectations that short‐term interest rates would need to be cut – as indeed they were.