Abstract
Numerous studies have found the term spread to be a significant predictor of future real output growth. However, in the case of the US, the term spread’s predictive power has diminished from the mid-1980s till present. This paper provides new evidence to the debate on why the term spread leads output growth. We do this by structurally accounting for the decline in the predictive power of the US term spread. Our findings indicate that it is changes to the composition of shocks hitting the US economy which has caused the term spread, through the endogenous monetary policy response, to be a less reliable indicator of future output growth in recent decades.
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