Nominal Term Spread, Real Rate and Consumption Growth
65 Pages Posted: 4 Jan 2013 Last revised: 13 Feb 2015
Date Written: December 1, 2014
Robust empirical evidence suggests that a steep slope of the nominal yield curve predicts an increase in the future real activity. We show that the negative of the slope closely traces the variation in the ex-ante real rate. We then argue that the predictive content of the slope for real activity empirically encapsulates the intertemporal tradeoff that arises in a broad class of equilibrium models. As a key implication, the estimates of the elasticity of intertemporal substitution (EIS) from the aggregate Euler equation are severely downwardly biased, implying a negative aggregate EIS. A model with heterogeneous agents and limited market participation can reconcile the positive EIS found in micro data with the negative relationship between the ex-ante real rate and aggregate consumption and output.
Keywords: Real interest rate, term structure of interest rates, Euler equation, elasticity of intertemporal substitution
JEL Classification: E12, E21, E43, G12
Suggested Citation: Suggested Citation