Predicting output using the entire yield curve

• The entire term structure of interest rates to predict future output growth.
• The Nelson–Siegel model to jointly model real GDP growth and yield factors.
• Better forecasts of real GDP than those generated by the term spread model.
• The main source of the forecast improvement is in the dynamic approach.
• A gain from using information in the curvature factor.

Many papers find that the term spread of the term structure of government bond yields can predict future output growth. This paper extends that literature by exploiting information in the entire term structure of interest rates. I apply a dynamic version of the Nelson–Siegel yield curve model to jointly model real GDP growth and yield factors. I find that the dynamic yield curve model produces better out-of-sample forecasts of real GDP than those generated by the traditional term spread model. The main source of this improvement is in the dynamic approach to constructing forecasts versus the direct forecasting approach used in the term spread model. While I confirm the importance of the term spread as a predictor of future output, there is also a gain from using information in the curvature factor.