INDICATOR PROPERTIES OF THE PAPER-BILL SPREAD - LESSONS FROM RECENT EXPERIENCE

A feature of U.S. postwar business cycle experience that is by now wid ely documented is the tendency of the spread between the respective in terest rates on commercial paper and Treasury bills to widen shortly b efore the onset of recessions. By contrast, the paper-till spread did not anticipate the 1990-1991 recession. Empirical work presented in th is paper supports two (not mutually exclusive) explanations for this d eparture from past experience. First, at least part of the paper-bill spread's predictive content with respect to business cycle fluctuation s stems from its role as an indicator of monetary policy, but the 1990 -1991 recession was unusual in postwar U.S. experience in not being im mediately precipitated by tight monetary policy. Second, movements of the spread during the few years just prior to the 1990-1991 recession were strongly influenced by changes in the relative quantities of comm ercial paper, bank CDs, and Treasury bills that occurred for reasons u nrelated to the business cycle. This latter finding in particular shed s light on the important role of imperfect substitutability of differe nt short-term debt instruments in investors' portfolios, and highlight s the burdens associated with using relative interest rate relationshi ps as business cycle indicators.