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584 Chapter 14 Introduction to Time Series Regression and Forecasting

Figure 14.3 Interest Rates and the Term Spread, 1960–2012

Percent per annum
16
14
12
10
8 10-Year interest rate
6
4 3-Month Interest Rate
2
0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

(a) 10-Year Interest Rate and Three-Month Interest Rate

Percent per annum
4
3
2
1
0
–1
–2
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

(b) Term Spread

Long-term and short-term interest move together, but not one-for-one. The difference between long-term rates and
short-term rates is called the term spread. The term spread has fallen sharply before U.S. recessions, which are shown
as shaded regions in the figures.

in the early 1980s, and both fell subsequently. But the gap, or difference, between
the two interest rates has not been constant: While short-term rates are generally
below long-term rates, the gap between them narrows and even disappears shortly
before the start of a recession; recessions are shown as the shaded bars in the
figure. This difference between long-term and short-term interest rates is called
the term spread and is plotted in Figure 14.3b. The term spread is generally posi-
tive, but it falls toward zero or below before recessions.

Figure 14.3 suggests that the term spread might contain information about the
future growth of GDP that is not already contained in past values of GDP growth.