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Forecasting Future Economic Growth: The Term Structure of Interest Rates, Volatility and Inflation as Leading Indicators

The broad literature documents the empirical
regularity that slope of the term structure of interest rates is a
reliable predictor of future real economic activity. Steeper slopes
presage increasing growth, and downward sloping term structures
presage declining growth or even recession. Some instances of
slope's misleading signals were recorded in 2006 (the term
structure was flat, indicating decline in economic activity when
high growth continued) and 2008 (the term structure was very steep,
predicting economic growth when recession continued and took a deep
dive). Moreover, Breeden (2012a) showed that the term structure of
interest rates has had less predictive power over the past fifty
years than has been found in earlier researches over shorter
periods of time. The key idea underlying this paper was to test
whether the term structure of volatility and the term structure of
inflation combined with the term spread could improve predictions
of future economic growth compared to interest rate based forecasts
with only one variable. This study finds that while the term
structure spread and volatility appear to be statistically
significant variables there is little evidence of improved
performance compare to interest rate based forecasts with only one
variable.