The leading indicator property of the term spread and the monetary policy factors in Japan

- Many studies have observed the leading indicator property of the term spread (LIPTS).
- We examine whether the LIPTS is related to monetary policy using Japanese monthly data.
- We find that the monetary policy plays an important role for the LIPTS.

Many studies have observed the leading indicator property of the term spread (LIPTS), which indicates that the term spread-the difference between long- and short-term interest rates-has information on future economic conditions. We examine whether this property is related to monetary policy or not by using Japanese monthly data with consideration for structural changes. Results of structural change tests show that the term spread has predictive ability for the future economic activity from 1982:4 to 1997:8. Decomposing the term spread into three parts; one is explained by past monetary policy shocks, another is explained by expected future call rates and the other is the remaining part, we find that all three parts are significantly related to the future economic growth rate. Hence, we find that the monetary policy plays an important role for the LIPTS.