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A time–frequency analysis of the Canadian macroeconomy and the yield curve

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Abstract

We use wavelet analysis to study the relationship between the yield curve and macroeconomic indicators in Canada. We rely on the Nelson–Siegel approach to model the zero-coupon yield curve and use the Kalman filter to estimate its time-varying factors: the level, the slope and the curvature. Apart from establishing a bidirectional yield–macro relation, the paper broadens the existing literature by exploring the link between the monetary policy and the yield curve. We reached several conclusions. First, the monetary policy variable, the bank rate, affects mainly short-run interest rates. Arguably, the main driver for economic activity is the long-run interest rate (instead of the short run), suggesting that monetary policy is mostly ineffective. Second, we concluded that concerning the inflation rate, the Bank of Canada is very proactive. Third, regarding the unemployment rate, we found that both the slope and the curvature are leading indicators for the long-run evolution of unemployment. Finally, our results suggest that the industrial production index leads the yield curve factors and not the other way.

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Notes

  1. Typically, the empirical measure for the slope is: \(\mathrm{Slope}_{t}=y_{t}(3)-y_{t}(120)\). Therefore, a negative value for the slope means that the interest rate is increasing with the maturity.

  2. Data downloaded from http://www.bankofcanada.ca/rates/interest-rates/bond-yield-curves/ on September 22, 2016.

  3. There is well-known bias regarding the estimation of the wavelet coefficients at the lowest scale levels. For that reason, we implement the correction proposed by the Liu et al. (2007).

  4. http://www.bankofcanada.ca/core-functions/monetary-policy/.

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Acknowledgements

The research unit of Aguiar-Conraria and Soares receives funding from COMPETE Reference No. POCI-01-0145-FEDER-006683, with the FCT/MEC’s (Funda ção para a Ciência e a Tecnologia, I.P.) financial support through national funding and by the ERDF through the Operational Programme on “Competitiveness and Internationalization—COMPETE 2020 under the PT2020 Partnership Agreement.

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Authors and Affiliations

  1. Economics Department, University of Minho, Braga, Portugal

    Mustapha Olalekan Ojo

  2. NIPE and Economics Department, University of Minho, Braga, Portugal

    Luís Aguiar-Conraria

  3. NIPE and Department of Mathematics and Applications, University of Minho, Braga, Portugal

    Maria Joana Soares

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  1. Mustapha Olalekan Ojo
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  2. Luís Aguiar-Conraria
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  3. Maria Joana Soares
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Correspondence to Luís Aguiar-Conraria.

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This work was carried out within the funding with COMPETE Reference No. POCI-01-0145-FEDER-006683, with the FCT/MEC’s (Fundação para a Ciência e a Tecnologia, I.P.) financial support through national funding and by the ERDF through the Operational Programme on “Competitiveness and Internationalization—COMPETE 2020 under the PT2020 Partnership Agreement.

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Ojo, M.O., Aguiar-Conraria, L. & Soares, M.J. A time–frequency analysis of the Canadian macroeconomy and the yield curve. Empir Econ 58, 2333–2351 (2020). https://doi.org/10.1007/s00181-018-1580-y

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