A predictive term-spread model in the age of inflation targeting

Abstract

The link between the shape of the US government bond yield curve and future economic growth is analysed using a novel real economy endowment model. The model suggests that the predictive power of bond market prices relies on the entire yield curve, i.e., on the long run interest rate level, the short-dated bond yield, the forecast horizon specific term spread and term premiums. A forecast horizon specific, maturity weighted, term spread is suggested as a supplement to extant one-factor term-spread models. The endowment model offers a theoretical basis for the findings of the recent empirical literature, which indicate predictive power of both the slope and curvature of the yield curve. The paper’s empirical section supports the observation that, in recent decades, the slope and curvature are predictors of US economic growth.