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A positive slope of the yield curve is associated with a future increase in real economic activity: consumption (nondurables plus services), consumer durables, and investment. It has extra predictive power over the index of leading indicators, real short-term interest rates, lagged growth in economic activity, and lagged rates of inflation. It outperforms survey forecasts, both in-sample and out-of-sample. Historically, the information in the slope reflected, inter alia, factors that were independent of monetary policy, and thus the slope could have provided useful information both to private investors and to policy makers. THE FLATTENING OF THE yield curve in 1988 and its inversion in early 1989have been interpreted by many business economists and financial analysts as evidence that a recession is imminent. Implicit in this interpretation is the presumption that a flattening of the yield curve predicts a drop in future spot interest rates and that these lower rates are associated with a lower level of real GNP. Recent empirical work on the term structure of interest rates confirms that changes in the slope of the yield curve predict the correct direction of future changes in spot rates, yet there is little empirical work on the predictability of changes in real economic activity.1 Indeed, given the near-random-walk empirical behavior of real GNP, a finding that the yield curve can predict future changes in real output would be very impressive.2 Predictability of changes in real output is associated with other equally important questions: How much extra information is there in the term for useful comments, and, for research assistance, James Chow. The views expressed in this article are our own and do not reflect those of the Federal Reserve Bank of New York or the Federal Reserve System. GNP and a distributed lag of the spread between the 20-year bond yield and the federal funds rate. Harvey (1988) examines the real term structure as a predictor of changes in consumption. 2For an interesting and thorough analysis of the permanent and transitory components in the growth rate of real GNP, see Cochrane (1988). 'Fama (1986) and Stambaugh (1988) present graphs showing that increases in forward rates precede economic expansions and decreases in forward rates precede recessions. Neither author performs a detailed statistical analysis. Laurent (1988) looks at the relationship between real 556The Journal of Finance structure that is not readily available in other published statistics? Should the term structure be included in the list of leading indicators? Should monetary policy use the term structure to extract information about future output, or is it the case that the yield curve reflects expected monetary actions alone? These are concerns that currently preoccupy the Federal Reserve, for in the latter case the slope of the yield curve would have no extra useful information for the conduct of monetary policy.Our paper is organized as follows: Section I reviews the recent evidence on the predictive power of the term s...

CLCqW ucjnqpi © uopcc 2 iCu o flJC 2oracc uo o cccccq o bvt ixbp um) pc dnoiuj jipon cxbjici bcuiaou bwiiqcq lp rnjj © ThÔ PX Vum.o EPCII uq LCCLC 2 VII P12 LT 2P°'4 C1!OU O iCXI KCL/ 21CUJ COI11UJP! flU!12!A 0L M!OU9! COUOUJIC C2CLCJJ c qioc o pc Vupoi2 uq uo qJo o w B'J1 o j.cM AOLr w cqcwj Lccm.cp &owwa u couowic ticwvjou uq oucjm.X cououijca vu? obw!ou2 cxbI.c2acq ouiJucq , qajccuc uqj v wwbcq j-qqT.ccq wjcr jpi bbcL bn.i o J4BEL2 ipa vucjc qj pc urnqc vivjpjc LCG o cpuLc ro icuX LC2CLCL po cuq n v wuqi.q fi,c iuy

A positive slope of the yield curve is associated with a future increase in real economic activity: consumption (nondurables plus services), consumer durables, and investment. It has extra predictive power over the index of leading indicators, real short‐term interest rates, lagged growth in economic activity, and lagged rates of inflation. It outperforms survey forecasts, both in‐sample and out‐of‐sample. Historically, the information in the slope reflected, inter alia, factors that were independent of monetary policy, and thus the slope could have provided useful information both to private investors and to policy makers.

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