Is the yield curve a useful information variable for the Eurosystem?

This paper deals with the use of the yield curve in monetary policy making. We argue that the yield curve's information content with respect to future inflation and real economic activity depends on correct identification of both the nature of shocks to the economic system and price behaviour. Identification is crucial, as there are alternative interpretations of an observed movement in the yield curve suggesting different monetary policy reactions. We show that identification on the basis of estimated equations may be problematic, using an empirical experiment in which a simple term structure model is applied to data on a large number of countries. This is especially relevant for the Eurosystem, as some evidence emerges for Lucas (1976)-type problems in our simple yield curve model. This finding questions the yield curve?s usefulness for policy evaluation in the early years of Stage Three. All in all, policy analysts should be cautious when using the yield curve as information variable for monetary policy.