Real Term Structure Forecasts of Consumption Growth

This paper employs an empirically tractable affine term structure model of real interest rates to examine the predictive ability of the real short-term interest rate and its term spread with a longer-term interest rate to predict future real consumption growth. The estimates of the model provide support of the consumption smoothing hypothesis. The paper shows that the real term structure is spanned by two mean-reverting state variables. The mean-reverting property of these variables can consistently explain the forecasting ability of the short-term real rate and term spread to forecast future consumption growth rate, over different horizons ahead. Although the risks associated with changes in these variables are both priced in the market, they are not volatile enough to obscure the information of the real term structure about future real consumption growth.