Using Interest Rates to Predict Economic Growth: Are Corporate Bonds Better?

Abstract

We consider whether government bonds, through the term structure, or corporate bonds, through the default yield, provide predictive power for output, consumption and investment growth. Such predictive power will allow policy-makers to use the information as a leading indicator for macroeconomic performance and improve our understanding of the links between real and financial markets. Full sample results suggest that both interest rate series exhibit predictive power for output and investment growth, while only the default yield has a significant relation with consumption growth. Time-variation in the predictive coefficient reveals the waning influence of the term structure and the rising influence of the default yield. Forecast results, which are obtained from a rolling window approach, likewise suggest both series have information content for macroeconomic conditions, but there is a change in their relative strengths. These results may arise as interest rates have declined since the highs of the early to mid-1980s thus reducing the information content of government yield, whereas corporate bonds respond more to investor views of macroeconomic risk, which affects a firm’s ability to repay its debt. Furthermore, short-term rates are held unprecedently low since the dotcom crash.