On the Predictive Power of Interest Rates and Interest Rate Spreads

   (403 K)

A number of interest rates and interest rate spreads have been found to be useful in prediction the course of the economy. We compare the predictive power of some of these suggested interest rate variables for nine indicators of real activity and the inflation rate. Our results are consistent with those of Stock and Watson (1989) and Friedman and Kuttner (1989), who found that the spread between the commercial paper rate and the Treasury bill rate has been a particularly good predictor. We present evidence that this spread is informative not so much because it is a measure of default risk (which has been the usual presumption), but because it is an indicator of the stance of monetary policy; for example, during the "credit crunches" of the l960s aid the 1970s, the commercial paper -- Treasury bill spread typically rose significantly. We also show that, possibly because of charges in monetary policy operating procedures aid in financial markets, this spread appears r to be a less reliable predictor than it used to be.

Published: New England Economic Review (Federal Reserve Bank of Boston) November-December 1990, pp. 51-68.

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