The Cyclicality of the Term Structure of Interest Rates
This paper highlights two stylized facts on the cyclical properties of the US yield curve. First, both the term spread and the term premium tend to increase during recessions. Second, there is a high, positive and persistent correlation between unemployment and both the term spread and the term premium. We present a complete macro-ﬁnance model with labor market frictions and unemployment which is consistent with these two facts. The model displays a ﬁnance-to-macro channel through ﬁnancial market segmentation in which the net worth of ﬁnancial intermediaries limits the degree of arbitrage across the term structure. A credit supply shock reduces the amount of funds available for ﬁnancial institutions to buy long-term bonds, increasing both the term spread and the term premium, and producing a persistent recession. In contrast, following a negative technology shock, often proposed as the driver of positive term premiums during recessions, the term spreads displays counterfactual dynamics.