Real Term Structure Forecasts of Consumption Growth

Abstract

This paper suggests an affine term structure model of real interest rates to predict changes in real consumption growth. The model is estimated, jointly, by real interest rates and consumption data, and it is found to be consistent with the consumption smoothing hypothesis. The paper shows that the real term structure is spanned by two common factors, which can be given the interpretation of the level and slope factors, respectively. The risks associated with these factors are priced in the market. Both of these factors can explain the information content of the short-term real interest rate and its term spread with longer term interest rate in forecasting future real consumption growth, over different periods ahead.

Keywords: real term structure of interest rates, Gaussian affine term structure models, price of risks, principal component analysis, consumption forecasting

JEL Classification: G12, E21, E27, E43