Wednesday, April 11, 2012

Interest Rate Slope Measures Future Economic Productivity (Total Factor Productivity)

From Federal Reserve Bank of St. Louis, Economic Research, "News Shocks and the Slope of the Term Structure of Interest Rates" Working Paper 2012-011A by André Kurmann and Christopher Otrok:
We adopt a statistical approach to identify the shocks that explain most of the fluctuations of the slope of the term structure of interest rates. We find that one single shock can explain the majority of all unpredictable movements in the slope over a 10-year forecast horizon. Impulse response functions lead us to interpret this shock as news about future total factor productivity (TFP). We confirm this interpretation formally by identifying a TFP news shock following recent work by Barsky and Sims (2011). By showing that the 'slope shock' and the 'TFP news shock' are closely related, we provide a new explanation for the relationship between the slope of the term structure and macroeconomic fundamentals and for why the yield curve is one of the most reliable predictors of future economic growth. Our results also provide a new empirical benchmark for structural models at the intersection of macroeconomics and finance.
Total Factor Productivity measures the growth in output, production and the economy that is greater than the growth in labor productivity and investment (capital, machinery) productivity. It is a very important, but rarely mentioned in the media, economic concept that determines a nation's future economic growth. For example, if a company doubles the number of workers making a product, it should produce twice as much. If the company buys a machine that allows each worker to make ten of its products in the same time it used to take to make one, the company should be able to produce ten times as much. Any additional gain in output beyond what is expected from the growth in labor and capital investment is due to total factor productivity. It is often attributed to things, such as learning to do things quicker or in a new way that was not obvious or doable before a new technology that allows more to be produced than before in the same time.

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