On the Predictive Power of Interest Rates and Interest Rate SpreadsOn the Predictive Power of Interest Rates and Interest Rate Spreads

November 26, 1990

Economists have long understood that financial market variables contain considerable information about the future of the economy. Recently a number of researchers have pointed out that interest rates and interest rate spreads--that is, differences between interest rates on alternative financial assets--can be effective predictors of the economy.

This finding raises a number of questions, possibly the most important being why interest rates and spreads predict the course of the economy so well. The author's tentative conclusion is that the spread between commercial paper and Treasury bill rates has historically been a good predictor because it combines information about both monetary and nonmonetary factors affecting the economy, and because it does this more accurately than alternative interest rate-based measures.

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