The Term Structure as a Predictor of Real Activity and Inflation in the Euro Area: A Reassessment

We study the informational content of the term structure of interest rates on future developments in inflation and real activity for the euro area, explicitly taking into account the possibility of a time-varying risk premium. We put forward a simple adjustment procedure for the term premium based on the rational expectations hypothesis of the term structure and provide evidence that the predictive content of term spreads for future developments in industrial production improves significantly if the adjusted term spread is used. The adjustment also achieves some (less systematic) improvements in the forecasting abilities of the term spread for headline inflation and core inflation. JEL no. E43, E44, E47