Economic Uncertainty and Interest Rates

Samuel M. Hartzmark

This Draft: August 19th, 2015

Abstract: Previous research presents a puzzle as to the weak relation between the
macroeconomy and the real interest rate, which this paper partially resolves. A number of asset-
pricing models predict a positive relation between the risk-free interest rate and expected
economic growth, and a negative relation between the interest rate and uncertainty of growth (i.e.
the conditional variance). I document that uncertainty and the interest rate have a strong negative
relation. This holds when examining up to 140 years of data, using various measures of
economic growth and uncertainty, and after controlling for inflation. The result has a number of
implications for models such as habit and long-run risks. A negative relation between habit and
the interest rate disappears after controlling for uncertainty and the relation is stronger for long-
run measures of uncertainty.

JEL Classification Codes: G12, E43

Keywords: Interest Rate, Uncertainty, Risk Free Rate, Consumption, Growth

The author is from the University of Southern California, Marshall School of Business, 3670 Trousdale Parkway,
Suite 308, Los Angeles, CA, 90089. Email at hartzmar@usc.edu. I would like to thank Kenneth Ahern, Wayne
Ferson, Stefano Giglio, Chris Jones, Scott Joslin, Stavros Panageas, Ralitsa Petkova, David Solomon, Andreas
Stathopoulos, Michael Weber, Fernando Zapatero and seminar participants at the European Finance Association
2013 meetings, Chicago Booth and the University of Southern California for helpful comments and suggestions.
In the concrete world, the most conspicuous characteristic of the future is its uncertainty.
-Irving Fisher (1907); The Rate of Interest: Its Nature, Determination and Relation to Economic Phenomena

Recent events underscore the importance of understanding how fluctuations in

macroeconomic uncertainty interact with asset markets. While uncertainty about future economic
growth is thought to have a broad impact on the economy, it is often empirically and
theoretically difficult to cleanly identify its influence. An exception to this, at least in theory, is
the interest rate. A central prediction of finance (with roots as early as Fisher (1907)) is that the
real risk free interest rate is determined by an intertemporal smoothing motive which induces a
positive relation between the interest rate and expectations of economic growth and a
precautionary savings motive which induces a negative relation between the interest rate and
uncertainty, the conditional variance of growth. This relation describes an important link
between uncertainty and a key economic variable that can be estimated with a minimum of
assumptions. However, there is currently little empirical evidence for the direct link between the
risk-free rate and macroeconomic uncertainty.
This paper examines this fundamental relation and finds that, consistent with the
precautionary savings motive, there is an economically and statistically strong negative relation
between the real interest rate and uncertainty. Regressing the real annualized three month
Treasury Bill rate on annual estimates of growth and uncertainty, a one standard deviation
increase in uncertainty is associated with a 1.2% to 2.3% decrease in the level of the risk free rate
when growth is measured by consumption, GDP or Industrial production. In each case these
coefficients have a t-statistic greater than three (in absolute value). The adjusted R2 of the model
increases from roughly 0 when using growth alone to 14%, 55% and 35% when both uncertainty
and growth are included in the regression.
As this pattern arises in a number of models and applications, I do not examine it within
the context of a specific model. The main contribution of this paper is to provide robust reduced
form empirical evidence of the link between economic uncertainty and the interest rate. Indeed,
the analysis in this paper is new in that it focuses on the broad pattern implied by precautionary
savings and ignores the specific cross-equation restrictions implied by various models. While
this limits the implications for a specific stochastic discount factor, it provides robust evidence
for precautionary savings without the limitation of jointly testing the numerous conflicting

2
restrictions imposed by each of the many models. By using a reduced form approach, along with
a number of different econometric specifications, data sources and time periods, the paper yields
a deeper understanding of a central economic variable, the interest rate, and how it is linked to
the macroeconomy.
The intertemporal smoothing and precautionary savings motives described by these
theories are based on expectations of growth and uncertainty, so the measurement of these
variables is key to the analysis. The baseline estimates described above are from an ARMA-
GARCH model fit in sample. Annual macroeconomic data are used as it is available for a long
and consistent time series beginning in 1934. While this analysis offers a natural starting point
for the empirical exercise, there are inherent limitations and to show robustness I explore other
data sources and methodologies.
One possible worry is that the time series of data is too short and does not allow enough
information to properly estimate the coefficients. While extending the time series necessitates
piecing together data from various sources, using historical data covering 140 years, an
economically and statistically significant negative relation between growth and uncertainty is
found. Using a quarterly time series of macroeconomic data covering a shorter time horizon, but
with more frequent observations, also yields a negative and significant relation between
uncertainty and the interest rate. The main analysis utilizes the 3-month treasury bill rate, but the
results also hold for the 30 day, 6 month and 1 year interest rates as well.
The US may be unique either due to the realization of random shocks in a single time
series or because of its special position in international asset markets. Indeed, an interpretation of
the negative coefficient on uncertainty is that in uncertain times there is a flight to quality, where
money floods into the US. This would depresses the interest rate in the US and increase the
interest rate abroad. International data from eight developed economies, Belgium, Canada,
France, Germany, Italy, Japan, the Netherlands, and the United Kingdom are examined.
Measuring growth using consumption or GDP, nearly all of the countries display an inverse
relation between the interest rate and uncertainty. This is not consistent with the negative
coefficient on the US relation being caused by a flight to quality.
Forecasts from the time series model fit in sample may not accurately reflect the ex-ante
variables in the model either due to weak forecasts or a look ahead bias. Weak growth forecasts
could lead to the spurious finding of a negative coefficient on the uncertainty term or the finding

3
of no relation between expected growth and the interest rate. Using ex-post realized growth
instead of estimates from a time series model yield similar results as do rolling time-series
estimates using only data known at the time yield similar results. Ex-ante forecasts from the
Survey of Professional Forecasters also yield a negative coefficient on uncertainty.
Perhaps the most commonly referenced ex-ante forecaster of uncertainty is the VIX
index. While only available for a short time period, the VIX is used to proxy for uncertainty
while both the Leading Index of the US and the Consumer Sentiment Index are used for monthly
growth forecasts. These measures are used in practice to forecast economic activity and do not
utilize the time series methods employed elsewhere in the paper. Testing the relation with these
measures yields a negative and significant association between the risk free rate and uncertainty.
I test empirical specifications suggested by the model for nominal interest rates, which
include the variance of inflation along with covariance terms between inflation and uncertainty.
Inflation risk is measured using a time-series model and also examining the dispersion of expert
forecasts. Controlling for these additional factors, the relation between growth and uncertainty
remains, suggesting that inflation risk is not responsible for the relation.
Econometric issues related to model choice and measurement error are examined and the
results are shown to be robust to many possible concerns. The pattern is not driven by outliers or
model choice regarding the number of lags in the ARMA process. The results are robust to using
longer sampling intervals and to econometric corrections for persistence in the regressors.
The early empirical work analyzing the risk-free rate and the macroeconomy presented a
puzzle as it found no empirical support for a link between the two. This was because these
studies assumed that there was no time varying uncertainty and thus only examined the relation
between the real interest rate and forecasts of growth (e.g. Hall (1978)). While some attempt
was made to reconcile the lack of an empirical relation between growth and uncertainty with the
theory (e.g. Campbell and Mankiw (1989)), it largely remained a puzzle as to why the interest
rate and the macroeconomy appear largely unrelated.
This paper helps to at least partially resolve the puzzle. First, the strong link between
uncertainty and the risk free rate shows that the theory has explanatory power, but that the
uncertainty channel is the strongest. Second, coefficients on growth for the US are not
significantly different from zero, but they are also not significantly different from the small
positive coefficients predicted by the long-run risk model. It may be that uncertainty is more

4
precisely measured than the expectation of growth (Merton 1980) and the measurement error
associated with growth could account for the lack of a significant empirical relation (Bansal and
Yaron 2004; Bansal, Kiku and Yaron 2012). Finally, extending the analysis to international data,
a number of countries display both a significant inverse relation between the interest rate and
uncertainty and a positive relation between the interest rate and growth. Thus the data support the
importance of an economic link between the risk free rate and the macroeconomy.
The results are based on a minimum of assumptions and thus are relevant to a number of
models. For example, a broad class of models, based on Campbell and Cochrane (1999),
examine the impact of time-varying risk aversion linked to external habit. The original model
utilizes i.i.d. consumption growth and a constant risk free rate, but subsequent papers have
relaxed this assumption yielding interest rates that vary with habit. This adds additional terms to
the interest rate process which could account for the relation between uncertainty and the interest
rate. Further, there has been a debate about the cyclicality of the risk free rate in these models –
Verdelhan (2010) requires a pro-cyclical interest rate to explain currency markets while Wachter
(2006) argues for a counter-cyclical interest rate to account for the domestic bond market.
Without controlling for uncertainty, habit has a negative and significant relation to the risk free
rate, but after uncertainty is accounted for, the relation between habit and the interest rate is weak
and insignificant. After controlling for habit, the coefficient on uncertainty is negative,
significant and roughly unchanged. The evidence is consistent with the risk free rate having a
strong relation with economic uncertainty, but not with time-varying risk aversion.
The long-run risks model (Bansal and Yaron (2004)) is one of the few models to include
time varying uncertainty. In this model, the precautionary savings motive is based on long-run
rather than short-run uncertainty. Empirically, both long-run and short-run measures of
uncertainty yield negative and significant relations with the risk free rate. After including both
measures of uncertainty in a regression, the short-run measure becomes insignificant while the
long-run measure remains large, negative and significant.
The central contribution of this paper is to provide empirical support and description of
the fundamental relation between economic uncertainty and the interest rate. While there is a
large literature exploring and modelling the properties of the interest rate, there is little research
exploring the economic causes of real interest rate behavior.1 Further the literature focusing on

1
For a recent survey see Neely and Rapach (2008)

5
the economics of the real interest rate has found little support for the theory, by focusing on the
relation between growth and the interest rate. This paper shows that while growth and the interest
rate have a noisy empirical relation, the relation between uncertainty and the risk free rate is
large lending strong support to the basic finance theory.
This paper contributes to the growing literature exploring how macorecoomic uncertainty
intersects with financial markets. For example, Bansal and Shaliastovich (2013) provide
evidence of a strong link between uncertainty and the bond risk premium. A number of recent
works provide direct evidence of a link between uncertainty and equity markets. Bansal,
Khatchatrian and Yaron (2005) and Nakamura, Sergeyev and Steinsson (2014) show that
increases in macroeconomic uncertainty decreases aggregate equity prices. Bansal, Kiku,
Shaliastovich and Yaron (2014) and Boguth and Kuehn (2013) examine the link between
uncertainty and risk premium.
This paper also contributes to the literature on the impact of uncertainty on the economy.
For example Bloom (2009) examines firm level data and finds that shocks to uncertainty
correspond to rapid drops and rebounds in employment and output. Bloom, Floetotto and
Jaimovich (2010) study the impact of uncertainty on the business cycle and find that increases in
uncertainty lead to drops in economic activity as do Justiniano and Primiceri (2008) who
examine a dynamic stochastic general equilibrium model with parameter uncertainty. This paper
adds further evidence that uncertainty is an important economic fundamental with wide ranging
impact.

2. A Basic Model
A number of asset pricing models imply a simple linear relation between the real interest
rate, growth and uncertainty of the form:
𝑟𝑡 = 𝛽0 + 𝛽1 𝐸𝑡 [𝑔𝑡+1 ] + 𝛽2 𝑉𝑎𝑟𝑡 [𝑔𝑡+1 ] (1)

Where rt is the log of the time t to t+1 risk free rate, gt+1 is the log consumption growth rate in
the subsequent period, Et is the expectation conditioning on information at time t, Vart is the
variance conditioning on information at time t and β0, β1 and β2 are constant coefficients. The ex-
ante variance of growth is what I term uncertainty.

6
 Of course Equation 1 could be, and has been, tested by imposing restrictions on the β
coefficients implied by various models, but each model implies different restrictions on the beta
coefficients. Appendix A shows that the simple discrete time representative agent model with
conditionally lognormal disturbances (as in Hansen and Singleton (1983), Ferson (1983) and
Harvey (1988)) along with a version of habit formation (Campbell and Cochrane (1999)) and
long-run risks (Bansal and Yaron (2004)) yield linear combinations of growth and uncertainty
that can be expressed using Equation 1. While the precise coefficients differs for the various
models, they each imply β1>0 and β2<0. This general prediction is the focus of my analysis.
In choosing to examine the broad prediction made by a number of models I am ignoring
the cross-equation restrictions implied by each of these models. For example, the classic log-
normal model tested by Hansen and Singleton (1983) suggests that β1 is equal to the coefficient
of risk aversion and β2 is equal negative one half of risk aversion squared. They, and the many
papers that followed, reject the model as it is not possible to empirically satisfy these restrictions
with the other cross-equation restrictions implied by the model.
This paper instead focuses on the economic intuition that precautionary savings should
induce a negative relation between the risk free rate and macroeconomic uncertainty. The short-
coming of this approach is that its direct implications for a specific model are limited. The
strength is that by examining a broad economic prediction made by a number of models this
paper provides direct empirical evidence of a strong link between the real risk free interest rate
and macroeconomic uncertainty without imposing the numerous and often conflicting
restrictions assumed by each of the separate models. The results are economically meaningful
not in their specific implications for a stochastic discount factor, but rather in that it demonstrates
that shifts in uncertainty are historically associated with large changes in the interest rate.

3. Data and Summary Statistics

Unless otherwise noted, growth is measured at an annual rate to avoid issues with
seasonal adjustment and extend the analysis to as many years as possible. All measures of
growth end in 2010. Growth is measured as the log of the ratio of the level measure
(consumption expenditures, GDP and output) at time t and the growth measure at time t-1. All
growth measures are in per-capita real dollars.

7
 This paper uses three different measures of economic growth. One is real consumption
growth from the National Income and Product Accounts (NIPA), where consumption is defined
as non-durable goods plus services. Real NIPA GDP is an alternate measure of growth as well as
the Federal Reserve’s G.17 real industrial production index. Consumption and GDP growth data
begin in 1930, while data on the Industrial Production index begins in 1920.
To extend the analysis, the above series is augmented with historical data. For
consumption the Kuznets-Kendricks series (Kuznets (1961), Kendrick (1961)) compiled by
Shiller (1982, 1989) is used which starts in 1890. Romer has argued that the methodology used
to compile this data accentuates fluctuations, making it more volatile than the economy actually
was. Chapman (1998, 2002) and Otrok, Ravikumar and Whiteman (2002) econometrically
examine the time-series of consumption and found similar evidence of structural breaks in the
data. Unfortunately there is not an alternative consumption series, but Romer (1989) has
compiled an alternative GNP series that is used from 1871. An industrial production index,
compiled by Miron and Romer (1990), is used which extends back to 1885. Results for quarterly
growth are presented as well where growth is measured as one plus the log of current level
divided by the level four quarters previous. The quarterly data begins in 1947.
Nominal interest rates are measured as the log of one plus the decimal fraction interest
rate. An annual rate is not available for the entire period of analysis so the rate is calculated by
annualizing the three month December rate, the last observation before the period of the growth
forecast.2 The main interest rate used is the 3 month Treasury bill rate from the Federal Reserve
Bank of St. Louis (TB3MS series) converted from a bank discount basis to an effective yield
basis. This series is available starting in 1934. An alternative measure of the interest rate is the
one month Treasury bill rate from Ibbotson Associates compiled by Fama and French. The first
full year of data is available for 1927. The 1 year interest rate is the GS1 series starting in 1954
and from 1947 to 1953 is from Homer and Sylla (2005). A historical series of the 6 month rate
(again, the December rate from the previous year annualized) is used which extend back to 1871.
This series is compiled using the 4-6 month prime commercial paper rate from Macauly (1938)

2
The December rate is chosen because it is the last value is known when the forecasts of growth are made.
Appendix Table 1 shows for the 3 month interest rate results are not materially different using the January rate,
compounding the rate from March, June, September and December, forecasting the annual rate compounded
from January, April, July and October using an ARMA(1,1) process, or simply using the ex-post realized rate.

8
from 1869 to 1937, the Federal Reserve from 1938 to 1970, the 6 month commercial paper rate
from 1971 to 1997 and the 6 month CD rate from 1997 to 2010.3
In the analysis, the interest rates are net of expected inflation. Annual inflation is
calculated as the log of CPI in December of year t divided by CPI in December of year t-1. This
is modeled using an ARMA(1,1) process and the predicted value is used as the estimate of
expected inflation (as in Constantinides and Gosh (2012)).4 This is subtracted from the log of the
interest rate to give the expected real interest rate. Section 4.5 analyzes whether the assumptions
necessary for this specification are supported in the data.
Table 1 presents summary statistics. All the measures of economic growth are positively
correlated, with GDP and consumption having a correlation of 0.53, industrial production and
consumption having a correlation of 0.47 and industrial production and GDP having a correlation
of 0.86. GDP and industrial production growth are more volatile than consumption growth, with
standard deviations more than twice as large. Also, consistent with the Romer critique of the
Kuznets series, consumption prior to 1930 is much more volatile than consumption after, with
double the standard deviation.
The Survey of Professional Forecasters, conducted by the Federal Reserve Bank of
Philadelphia, provides an alternative forecast of growth, presumably made using a richer
information set than simply the lagged values of growth. The survey is timed to coincide with the
release of the advanced estimates from the previous quarter, so the forecast of growth is made in
the 1st quarter of the year when the value for the 4th quarter from the previous year is known.
Thus the estimate of growth is the log of the forecast for the 4th quarter of year t+1 divided by
the known value of the 4th quarter in year t. The time series of data is relatively short with real
consumption growth calculated from 1981, and GDP and Industrial production calculated from
1968. Forecasts of inflation are calculated in the same manner as forecasts of growth using
forecasts of the GDP price index from 1968.
Results using ex-ante forecast data are presented using the VIX to proxy for uncertainty,
and the Leading Index for the United States and the University of Michigan Consumer Sentiment
Index to proxy for growth. Each variable is analyzed in logs. The VIX index begins in 1990 and

3
This is the same data sources as Shiller (1989), though Shiller uses the ex-post realized rate of rolling over in
January and July, while I use the December rate annualized to avoid any forward looking bias.
4
In untabulated results I find materially similar results calculating the real interest rate using the methodology of
Beeler and Compbell (2012) and Bansal, Kiku and Yaron (2012).

9
is constructed using options data to measure the 30-day expected volatility of the S&P 500.5 To
deal with the short time series, growth forecasts that are available monthly are utilized. The
leading index corresponds to a 6 month forecast, constructed using forward indicators such as
housing permits, and unemployment insurance claims, among others. The Consumer Sentiment
Index is based on a monthly telephone survey meant to gauge consumer confidence.6
Finally I use data on 8 international developed countries, namely Australia, Belgium,
Canada, France, Italy, Japan, the Netherlands and the United Kingdom. These are the countries
with a long time series of data available. Consumption and growth is from Barro and Ursúa
(2008) the 3 month treasury rate and CPI for each country is from Global Financial Data.7

4. Empirical Results
4.1. Baseline Results
To analyze the linear relation from Equation 1, estimates of expected economic growth
and the variance of economic growth are needed. As a baseline case I model growth as a time
series process. The most basic formulation is to model growth as ARMA(1,1):8
𝑔𝑡+1 = 𝜑𝑔𝑡 + 𝜃𝜀𝑡 + 𝜇 + 𝜀𝑡+1 (2)
After estimating the model, it is used to predict ĝt+1 which is then used as the estimate for
Et[gt+1] in Equation 1. The simplest way to estimate Vart[gt+1] is as the square of the residuals in
period t, so the estimate of the variance is (ĝt -gt)2. Table 2 Panel A takes the estimates from this
model to estimate Equation 1.
To improve the estimate of uncertainty, Table 2 Panel B models growth as a
conditionally heteroscedastic process using a GARCH(1,1) model (Engle (1982), Bollerslev
(1986)). The specification used is:
𝑔𝑡+1 = 𝜑𝑔𝑡 + 𝜃𝜀𝑡 + 𝜇 + 𝜀𝑡+1
(3)
𝑉𝑎𝑟𝑡 (𝜀𝑡+1 ) = 𝛾 + 𝛼1 𝜀𝑡2 + 𝛼2 𝜎𝑡2

5
For a more complete overview of the VIX see the CBOE white paper on its construction available at:
http://www.cboe.com/micro/vix/vixwhite.pdf
6
For literature surrounding the leading index see Stock and Watson (1989, 1991), Hamilton and Perez-Quiros
(1996), Crone (2003). For literature surrounding the predictive power of Consumer sentiment see Carroll, Fuhrer
and Wilcox (1994), Matsusaka and Sbordone (1995) and Howrey (2001).
7
Where monthly data is available the interest rate is based on the December average. When only annual data is
available the annual measure is used.
8
Appendix Table 2 shows results of the basic estimation for different ARMA lags and shows lag choice does not
materially change the results.

10
This yields a forecast for growth and uncertainty that the agent can undertake at time t if the
agent knows the time series model of the economy.
Table 2 estimates Equation 1 using annual data on consumption, GDP and industrial
production as measures of growth. For all three measures, and using both methodologies for
measuring the variance, the uncertainty term is negative and statistically significant. Further, in
none of the specifications is growth significant.
Table 2 suggests that there is a strong relation between the interest rate and future
economic uncertainty. Examining the final row of Table 2 Panel B, “Impact of 1 SD Vart[gt+1]”,
a one standard deviation increase in the risk free rate is associated with a 0.012, 0.023, and 0.018
decrease in the interest rate for consumption, GDP and industrial production respectively.
Further, the variance adds significant explanatory power to the model over simply
including growth. The row labeled “Adjusted R2” gives the adjusted R2 of the estimated model,
while the row labeled “R2 Excluding Vart[gt+1]” gives the adjusted R2 for the model regressing
the interest rate on the growth forecast while excluding the variance term. Using the residual
measure of variance in Panel A, the adjusted R2 value significantly increases in all specifications
from zero without the uncertainty term to 0.08, 0.42 and 0.15 for consumption, GDP and
industrial production respectively. Similarly, using the GARCH specifications this value moves
from roughly 0 without uncertainty to 0.14, 0.55 and 0.35 with uncertainty included.
Table 2 Panel B contains the main results using, in my opinion, the best blend of
econometric specification and data available. Consistent data from the same source exists for the
entire period for all measures of the interest rate, inflation and growth. While the ARMA-
GARCH framework has its shortcomings, other options, such as expert forecasts or the VIX,
exist only for relatively short time periods and have their own set of issues. Nevertheless, in most
specifications examined, the relation between the interest rate and uncertainty remains robust,
negative and economically meaningful.
4.2. The Effects of Extreme Volatility Periods
Figure 1 graphs data from the ARMA-GARCH model in Table 2 Panel B. Predicted
consumption growth is the solid green line and the risk free interest rate is the dashed orange
line. Sometimes these lines seem to move together, for example during the 2000s and
surrounding WWII, while during other periods they follow very different paths, for example in
the early 1980s. There does not appear to be a strong relation between these two series.

11
 Figure 2 graphs the variance of consumption growth as the solid green line versus the
interest rate as the dashed orange line. There are some periods with very high volatility. The
periods with the highest volatility occur during major events in US economic history. The first
period is the forecasts for 1937 (based on data from 1936) which coincides with the recession
within the great depression. The next period occurs in the forecasts for 1948 as the US emerged
from WWII. Another year with high volatility is 1975 as the US dealt with the first OPEC oil
embargo. The final high volatility period occurred in 2010 during the recent financial crisis.
To show the results are not driven by the large relative magnitudes of these periods, the
data is winsorised at the 90th percentile with the results presented in Table 3. All of the results
remain robust to this change. The significance of the variance coefficient, adjusted R2, and the
impact of a one standard deviation change are slightly stronger for consumption and industrial
production and slightly weaker for GDP. Table 3 suggests that the results are not driven by
outliers in the data.
4.3. The Long Historical Record
The preceding analysis begins with data starting in 1934, the first year that the 3 month
risk free rate is available. In this section the analysis is extended to the maximum extent possible.
This means using the historic interest rate data, which begins in the late 1800s. GDP using the
Romer series begins in 1871, and industrial production, using the Miron and Romer estimates
begins in 1885. For consumption, the Kendrick-Kuznets series is used, which begins in 1890.
Figure 3 graphs the extended Kendrick-Kuznets consumption series with the red vertical
line indicating 1930, the first year NIPA data is used for the growth rate. Prior to the NIPA data,
there is significantly more volatility. From 1934 to 2010, the period the initial analysis was
conducted on, the standard deviation is 0.024. Before this period, from 1890 to 1933, the
standard deviation is 0.049, more than double the subsequent period. This is not true with the
interest rate, which actually has a higher standard deviation in the later period, 0.025 prior to
1934 and 0.31 after. Romer (1989) argues that the higher volatility of the Kendrick-Kuznets
series is due to the methodology of its construction, and not actual shifts in the economy. Note
that the Romer GNP series is slightly less volatile from 1871 to 1929, than the NIPA series from
1930 to 2010. If the consumption series is artificially noisy, the estimates will be attenuated. To
partially offset this, the standard analysis is presented, as well as an analysis where the estimates
of growth and variance are winsorised at the 90th percentile.

12
 Table 4 presents the evidence that the relation is strong over this long historical record.
First note that all the variance terms are again negative, and everything other than the
uncorrected consumption is significant at the 10% level. The relation with consumption is
weaker in terms of adjusted R2 and overall impact, though it is improved slightly after
winsorising. This is unsurprising given Romer’s critique of the Kendrick-Kuznets data
artificially increasing the size of its fluctuations.
Using the Romer series, the pattern with GDP and industrial production remains robust.
The adjusted R2 increases when uncertainty is included in the model. The R2 is lower than it was
during the shorter period. This is unsurprising, as the regressions cover 140 years including many
different economic episodes, periods and policies. However, the general pattern remains
significant. The growth forecast term is positive in all specifications, but it is only significant at
the 5% level when using industrial production. The impact of a one standard deviation increase
in uncertainty is associated with a greater than 0.01 decrease in the interest rate for both GDP
and industrial production.
4.4. Quarterly Data
The previous analysis uses annual data as it is available for the longest time period and
does not suffer from being seasonally adjusted. As a further robustness check Table 5 presents
the same specification as Table 2 panel B using quarterly data. The benefit of the quarterly data
is that it is higher frequency and may not suffer from the structural breaks in the data that occur
over the long time-series (Chapman 1998, Otrok, Ravikumar and Whiteman 2002). The quarterly
data begins in 1947, so major events effecting uncertainty such as World War II and the great
depression are not included. Further concerns about persistent regressors are greater for these
regressions as the sampling occurs quarterly as opposed to annually. Finally the seasonal
adjustment may be taking out relevant variation from the data and biasing results (Ferson and
Harvey (1992)). All growth rates are annualized for comparability with the previous estimates.
Table 5 shows that in general the results remain robust to using the shorter time period in
the quarterly sample, though they are weaker for GDP. All three measures of variance are
negative, though GDP is no longer significant. Further, in all three specifications the adjusted R2
increases versus the specification excluding the variance.

13
4.5. Different Interest Rates
The analysis up to this point utilizes the 3 month interest rate. Next the model is
estimated using a variety of alternative interest rates. The interest rates with data available for
this period are the 30 day interest rate, the 3 month interest rate, the 6 month interest rate and the
1 year interest rate. Table 7 presents estimates. Notice that the main patterns discussed in the
previous section are all present for each maturity. The expected growth is insignificant, while the
variance is negative and significant. The portion of the data explained using the variance versus
not, is significantly higher as measured by the adjusted R2. Thus the choice of short term interest
rate does not appear to be an important factor for the results.
4.6. International Data
Finally, I analyze the relation by examining countries other than the US. Extending the
analysis to other countries allows for more observations and alternate time series to analyze
whether the US relation is simply an anomaly. Eight different developed countries are examined
and estimates for growth and uncertainty are obtained by estimating a separate ARMA-GARCH
model for each country as specified by Equation 3.
Table 6 examines each country individually using consumption as a measure of growth in
Panel A and GDP in Panel B. Again the results are robust and similar to the US results. All eight
of the countries have negative coefficients on the uncertainty term and six of them are significant
at the 5% level. When examining GDP in Panel B, seven of the eight coefficients on uncertainty
have a negative sign and five of the eight are significant at the 5% level.
The international results are also offer some support for the link between growth and the
interest rate albeit not as robustly as that between the interest rate and uncertainty. Examining the
results utilizing consumption in Panel A six of the eight coefficients on growth are positive and
three are significant at the 5% level. Examining the results using GDP in Panel B four of the
eight are positive with three significant at the 5% level.

5. Using Alternative Forecasts

5.1. Using Ex-Post Growth
The estimates of growth to this point are from time series models which may not
accurately reflect the expectations of the market. The base interest rate relation implies that
growth should be positively correlated with the interest rate, but none of the β1 coefficients are

14
significant and in some cases the point estimates are negative. Both the growth and uncertainty
term are measured with error which should attenuate the estimates if they are uncorrelated and
random. It is possible that the forecast of growth is measured with more error than the variance
term and that the significance of the variance term is driven by unmeasured variation in growth.
To test for this, Table 8 Panel A presents estimates of Equation 1 using ex-post realized
growth instead of the growth forecast. This introduces a different bias to the forecast term as the
agent does not know this value at time t, but if the results are being driven by systematically
failing to measure the agent’s expectations, the ex-post realized value should present a worst
case scenario for the errors in variables bias. All of the previous results remain materially
unchanged when using ex-post growth. Thus it is unlikely that measurement error of the forecast
term is driving the uncertainty coefficient.
5.2. Using Professional Forecasts
Table 8 Panel B presents another robustness check to the growth forecast by using an
alternative measure of growth from the Survey of Professional Forecasters. This table estimates
the panel regression:
𝑟𝑖,𝑡 = 𝛽0 + 𝛽1 𝐸𝑖,𝑡 [𝑔𝑡+1 ] + 𝛽2 𝑉𝑎𝑟𝑡 [𝑔𝑡+1 ] (4)
where i indexes each individual expert and t indexes time. 𝑟𝑖,𝑡 is an expert’s forecast of the real
risk free rate based on their estimate of inflation and 𝐸𝑖,𝑡 [𝑔𝑡+1 ] is their estimate of growth. By
using a panel format it is possible to match a given expert’s estimate of the risk free rate with
their estimate of growth.9 The variance term does not vary by expert and is specified by Equation
3. Standard errors are clustered by both time and expert. Using the same measure of uncertainty
with different measures of inflation and growth serves as another test as to whether
systematically biased estimates from the ARMA model for growth are responsible for the
negative relation between the interest rate and uncertainty.
The results using the expert forecast data are consistent with those presented previously.
While GDP is no longer statistically significant, the β2 coefficients for consumption and
industrial production are strong with a t-statistic greater than 4. All three are still economically
significant with a one standard deviation increase in uncertainty being associated with decreases

9
Similar results are obtained using the median value of panelists at time t, estimating the relation analogously to
Equation 1.

15
in the risk free rate of 0.011, 0.010 and 0.041 for consumption, GDP and industrial production
respectively. Even though there are fewer years, the main results are still present.
Aside from weak forecasts, another concern is that the time series model used induces a
look ahead bias that accounts for the results. The baseline model is estimated using data through
the entire sample. If the agent knows this model at time t, the agent can make forecasts using it,
but perhaps the model is not known and the results are biased.
Figure 4 graphs the forecasts from the time series model versus the median expert
forecast for the survey of professional forecasters. The expert forecasts were made by
professionals using only ex-ante knowledge. While not identical, the two series move closely
together throughout the period where there is data for both. This suggests that the forecasts from
the model are not driven purely by a look ahead bias, at least for these years.
As a further test, Table 8 Panel C estimates the relation where the forecasting model is fit
using data only for the years up to time t to forecast period t+1. The model is estimated
separately for each year adding in the new year of data and starting using a minimum of 15
observations. Using this rolling estimation technique negative and significant coefficients are
found for consumption and industrial production and GDP is no longer significant. While
slightly weaker, this suggests that a look ahead bias is not responsible for the empirical relation.
5.3. Using the VIX
This section examines the robustness of the previous results by using ex-ante forecasts of
both growth and uncertainty. The VIX index is utilized to proxy for uncertainty. The VIX
corresponds to stock market volatility which, while related to economic uncertainty, is not a
perfect proxy. That being said, the VIX is probably the best ex-ante forecaster of economic
uncertainty at our disposal (e.g. Bloom 2009). The major shortcoming for this paper is that the
data on the VIX begins in 1990. Thus, there is only a short time series to estimate the relation so
VIX is not used as the baseline measure of uncertainty even though it would be an ideal measure
if it were available for the full sample period.
To deal with the short time series of data, monthly forecasts from the Leading Index for
the United States and the University of Michigan Consumer Sentiment Index are used for
growth. This section, and this section only, utilizes nominal values for all variables. The VIX
measure is nominal volatility and the horizon of consumer sentiment is unclear. Given the stable,

16
low level of inflation over this period, similar results in both significance and magnitude are
obtained assuming a number of different specifications for inflation.
The VIX, the leading index and the consumer sentiment index are each constructed using
data available at the time they are reported and are used in practice for forecasting purposes.
Thus finding an inverse relation between the VIX and the interest rate underscores that the
previous analysis is not driven by assuming a specific time series structure.
Table 9 presents estimates for the relation utilizing the VIX. Panel A utilizes a Newey-
West regression framework, while Panel B utilizes the mARM correction (discussed in section 7)
to deal with persistent regressors. In all specifications the relation between the interest rate and
the VIX is negative and significant. The relation between the Leading Index and the interest rate
is not significant, while the consumer sentiment index is positive and significant. Thus the
interest rate and uncertainty retain a negative and significant relation, even when examining a
shorter period of time, utilizing different data and different techniques.

6. Inflation Risk
The previous discussion assumes the existence of a risk-free rate for which there is no
perfect analog in the data. For the initial analysis inflation is predicted using an ARMA(1,1)
process and the real rate is constructed by subtracting predicted inflation from the nominal
interest rate. Using this method, the data suggest that economic growth risk is important for
understanding the general equilibrium relation between economic uncertainty, economic growth
and the risk free interest rate. This ignores any inflation risk premium. The simple discrete time
representative agent model with conditionally lognormal disturbances discussed in Appendix A
𝑁
can also be re-stated using variables for nominal interest rates, 𝑅𝑗,𝑡 and inflation, It+j, which is
unknown at time t as:

𝑗
𝐶𝑡+𝑗 −𝛼 1 + 𝑅𝑗,𝑡
𝑁
𝐸 {𝛿 ( ) ( )} = 1 (5)
𝐶𝑡 1 + 𝐼𝑡+𝑗
Re-arranging this and taking logs:

17
 𝑁
𝑙𝑛(1 + 𝑅𝑗,𝑡 ) − 𝐸𝑡 [𝑙𝑛(1 + 𝐼𝑡+𝑗 )]
𝐶𝑡+𝑗 𝛼2 𝐶𝑡+𝑗
= −𝑗𝑙𝑛(𝛿) + 𝛼𝐸𝑡 [𝑙𝑛 ( )] − 𝑉𝑎𝑟𝑡 [𝑙𝑛 ( )]
𝐶𝑡 2 𝐶𝑡 (6)
1 𝛼 𝐶𝑡+𝑗
+ 𝑉𝑎𝑟𝑡 [𝑙𝑛(1 + 𝐼𝑡+𝑗 )] + 𝐶𝑜𝑣𝑡 [𝑙𝑛 ( ) , 𝑙𝑛(1 + 𝐼𝑡+𝑗 )]
2 2 𝐶𝑡
With inflation uncertainty there are new terms for the variance of inflation and the covariance
between consumption growth and inflation. In order to examine the impact of inflation
uncertainty on the results I estimate:
𝑟𝑡 = 𝛽0 + 𝛽1 𝐸𝑡 [𝑔𝑡+1 ] + 𝛽2 𝑉𝑎𝑟𝑡 [𝑔𝑡+1 ] + 𝛽3 𝑉𝑎𝑟𝑡 [𝑖𝑡+1 ]
(7)
+ 𝛽4 𝐶𝑜𝑣𝑡 [𝑔𝑡+1 , 𝑖𝑡+1 ]
where it+1 is the log of one plus inflation. The variance of inflation measures the uncertainty of
inflation from t to t+1. The covariance captures the real impact of inflation, through its relation
to real economic growth.
For this reduced form empirical model both inflation and consumption growth are
modeled using an ARMA(1,1)-GARCH(1,1) specification as described by Equation 3. The
covariance term is modeled by assuming the residual from the forecast of inflation multiplied by
the residual from the forecast of growth follows an ARMA(1,1) process. Thus the covariance
term is forecast using the equation:
𝑔 𝑔𝑖
𝐶𝑜𝑣𝑡+1 (𝑔𝑡+1 , 𝑖𝑡+1 ) = 𝛾 + 𝛼1 𝜀𝑡 𝜀𝑡𝑖 + 𝛼2 𝜎𝑡 (8)

𝑔𝑖
Where 𝜎𝑡 is the covariance between growth and inflation at time t.
The first column of Table 10 Panel A presents the estimates of Equation 7 using the 3
month interest rate and the three measures of growth. The regression includes the same variables
as Equation 1, but also the variance of the inflation rate and the covariance term. In all estimates
of Equation 7, the coefficient on uncertainty is negative and significant at the 10% level. Adding
the variance of inflation decreases the adjusted R2 for all three measures of growth as compared
to Table 2 Panel B. A one standard deviation increase in growth is associated with decreases in
the interest rate of -0.011, -0.027 and -0.15 for consumption, GDP and industrial production
respectively. These are generally consistent with the numbers obtained when the inflation terms
are not included. Thus the results do not appear driven by simplifying assumptions related to
changing the nominal rate to real.

18
 The estimates of inflation risk in Panel A are from a time series model which may not
yield appropriate forecasts. Table 10 Panel B repeats the panel analysis described by Equation 7
where inflation risk is proxied using the variance of expert forecasts of inflation. All coefficients
remain negative, though GDP is insignificant and a one standard deviation change in uncertainty
is associated with economically meaningful changes to the risk free rate.

7. Econometric Issues
All of the variables in the above regression have a degree of time series persistence.
Indeed the GARCH model was created to deal with data series that exhibited persistence in
volatility (Engle (1982), McNees (1979)). Using one year intervals and Newey-West standard
errors, the previous analysis attempts to control for this. This section examines the issue further
to see if it was sufficient. After a number of tests to examine the impact of persistent regressors,
all of the results remain.
First, a conservative, back of the envelope result is presented taking an observation once
every 5 years instead of annually. The 5 year sampling interval is chosen to be large enough to
mitigate concerns about persistent regressors. If the results disappear it raises the concern that the
empirical relation is driven by econometric bias rather than a true economic relation. Further, this
test discards a large amount of data to obtain a long sampling interval. Even if the full sample
results are not being driven by persistent regressors, it is possible that no relation will be found
simply due to the small sample size of 16 observations. Thus this is a conservative test that is
biased towards rejecting the relation even if persistence is not responsible for the results.
Table 11 Panel A presents estimates taking one observation every 5 years and shows that
the results are largely unchanged. The data starts in 1935, examining 1940, 1945 and so on until
2010. The coefficient on the variance is more negative on consumption, less negative on GDP
and slightly more negative on industrial production compared to Table 2. All coefficients are
statistically significant, and all estimates of the impact of a one standard deviation change in
variance are economically significant. All adjusted R2 are much higher when uncertainty is
included in the regression. Thus the back of the envelope test suggests that the results are not
being spuriously driven by persistent regressors.
Kendall (1954) and Stambaugh (1999) show that there is a finite sample bias when
regressors are autoregressive with errors that are correlated with the dependent variable. Amihud

19
and Hurvich (2004) and Amihud, Hurvich and Wang (2009) develop the mARM method for
estimating unbiased coefficients and test statistics of multi-variate models with persistent
regressors. Appendix B contains a description of the implementation used here.
Table 11 Panel B presents the adjusted regression. After the correction, all estimates of
the coefficient on uncertainty are negative and significant. The coefficients on consumption,
GDP and industrial production have t-statistics of -4.00, -6.22 and -5.63, respectively. Also note
that the order of magnitude of the estimates is similar, suggesting that bias is not greatly
impacting the coefficients.

8. Implications of Specific Models

8.1. External Habit
Campbell and Cochrane (1999), examine the impact of changing risk aversion caused by
deviations from slow moving external habit. Adding habit can create additional habit based
components to the interest rate process. This section examines whether these components
account for the negative relation found between uncertainty and the interest rate. After
controlling for habit, a robust relation between the interest rate and uncertainty remains. After
accounting for uncertainty, the habit based terms add little explanatory power.
The benchmark model of habits (Campbell and Cochrane (1999)) cannot directly speak to
the analysis in this paper as it assumes i.i.d. consumption growth – thus there are no fluctuations
in consumption volatility. Prior to specifying the sensitivity function, 𝜆(𝑠𝑡 ), where st is the log of
𝐶𝑡 −𝑋𝑡
surplus consumption 𝑠𝑡 ≡ 𝑙𝑛 ( ), the risk free interest rate contains additional linear terms to
𝐶𝑡

the affine function found in this paper based on habit. In the Campbell and Cochrane (1999)
model the sensitivity function is chosen so that these terms perfectly offset. The constant
expectations of growth and uncertainty combined with this sensitivity function yields a constant
risk free rate.
Alternative habit based models feature risk free rates that vary with habit, but offer
differing predictions in how it does so. For example, Wachter (2006) builds a model of the term
structure based on external habit formation utilizing a risk free rate that is linear in surplus
consumption. In order for the model to generate an upward sloping yield curve and a positive
risk premia on real bonds, the intertemporal smoothing motive must dominate. Wachter offers
support for this hypothesis by regressing the interest rate on surplus consumption and finding a

20
negative coefficient. On the other hand Verdelhan (2010) builds a model with interest rates that
are procyclical in order to explain the uncovered interest rate parity puzzle. Thus the dominant
motive has important implications for the cyclicality of the risk-free rate and there is
disagreement on what it should be.
I replicate the Wachter result using annual data and the longer time period studied in this
paper to show that without further controls, the negative relation between surplus consumption
and the interest rate is robust. I use the same proxy for surplus consumption, a slow moving
weighted average of past consumption, and estimate:
10

𝑟𝑡 = 𝛽0 + 𝛽1 ∑ ϕ𝑗 𝑔𝑡−𝑗 + 𝜀𝑡+1 (9)

𝑗=1

Surplus consumption is measured over a 10 year period as ∑10 𝑗

𝑗=1 ϕ 𝑔𝑡−𝑗 , where ϕ=(0.97) .
4

Table 13 Panel A presents the results. The relation is negative and is significant for GDP
and industrial production. Thus, both economic uncertainty and surplus consumption are
negatively correlated with the level of the interest rate.
While the i.i.d. consumption growth in the above models of habit cannot directly speak to
the analysis in this paper, a handful of papers have relaxed this assumption (e.g. Bekaert 1996,
Bekaert and Engstrom 2009, Ermolov 2014). For a recent example, Ermolov (2014) builds a
habit based model with heteroskedastic consumption growth shocks which yields a risk-free rate
of the form:
𝑟𝑡 = 𝛽0 + 𝛽1 𝑠𝑡 + 𝛽2 𝑉𝑎𝑟𝑡 [𝑔𝑡+1 ] (10)
after collapsing a number of constant parameters into the 𝛽 terms. Consistent with the other
models discussed in this paper, the model predicts 𝛽2 < 0. Thus in this model the investor wants
to smooth consumption based on their habit (𝑠𝑡 ), but exhibits precautionary savings with respect
to uncertainty.
In the empirical analysis it could be that uncertainty captures the impact of surplus
consumption, or surplus consumption captures the impact of uncertainty, so it is necessary
to control for both to understand the relation these variables have with the interest rate.
First I estimate the regression suggested by the Ermolov model, which takes the Wachter
regression from Equation 10 and adds uncertainty to estimate:

21
 10

𝑟𝑡 = 𝛽0 + 𝛽1 ∑ ϕ𝑗 𝑔𝑡−𝑗 + 𝛽2 𝑉𝑎𝑟𝑡 [𝑔𝑡+1 ] + 𝜀𝑡+1 (11)

𝑗=1

Next I also allow for time varying growth and estimate:

10

𝑟𝑡 = 𝛽0 + 𝛽1 𝐸𝑡 [𝑔𝑡+1 ] + 𝛽2 𝑉𝑎𝑟𝑡 [𝑔𝑡+1 ] + 𝛽3 ∑ ϕ𝑗 𝑔𝑡−𝑗 (12)

𝑗=1

Table 12 Panel B shows a strong relation between uncertainty and the risk free rate
and a weak relation between the risk free rate and habit after both are included. The first
column under each growth measure presents estimates utilizing Equation 11. After
controlling for surplus consumption, all three measures of growth yield negative and
significant coefficients on uncertainty that are a similar magnitude to those found without
controlling for surplus consumption. Compared to the specification with surplus
consumption alone, adding uncertainty and growth increases the adjusted R2 from 0.04 to
0.16 using consumption, 0.21 to 0.57 using GDP and 0.12 to 0.36 using industrial
production. The next column allows for time-varying growth and finds a similar pattern.
The coefficients on surplus consumption moves from negative and significant in Panel A, to
roughly zero in all three specifications in Panel B. The signs of the point estimates on
surplus consumption are not consistent across growth measures, and none are significant.
Surplus consumption is unable to account for the negative relation between
uncertainty and the interest rate. After uncertainty is added to the regressions, the relation
between surplus consumption and the interest rate is weak. This suggests that changes to
risk aversion based on habit are not a major factor for understanding the interest rate,
while uncertainty and the interest rate have a strong connection.
8.2. Long-Run Risks
The long-run risks model is one of the few models to include time varying uncertainty.
The interest rate is modeled as linear in growth and uncertainty, so the results in this paper add to
the empirical literature on long-run risks (Bansal and Yaron (2004); Bansal, Khatchatrian and
Yaron (2005); Bansal, Kiku and Yaron (2007); Bansal, Kiku and Yaron (2012); Ferson
Nallareddy and Xie (2013); Jaganathan and Marakani (2011)).
The long-run risks interest rate is linear in growth and uncertainty and, as discussed in
Appendix A, can be written as:

22
 𝑟𝑡 = 𝐴𝑓 + 𝐴1,𝑓 𝐸𝑡 [𝑔𝑡+1 ] + 𝐴2,𝑓 𝑉𝑎𝑟𝑡 [𝑔𝑡+1 ] (13)
Each of these As are constant parameters of the model. While the coefficients include different
model parameters than the motivating example in Section 2.1, the interest rate is the linear
function of growth and uncertainty examined in this paper.
In the long-run risks model, asset prices are impacted by a persistent predictable
component of consumption growth and a persistent predictable component of uncertainty. Thus,
similar to Beeler and Campbell (2012), this paper finds that the interest rate does not forecast
future economic growth, which is a puzzle for the long-run risks model. Bansal and Yaron
(2004) and Bansal, Kiku and Yaron (2012) argue that regressing the risk free rate on
consumption growth without including uncertainty will lead to a downward bias on the
coefficient on growth. Beeler and Campbell (2012) argue that such a bias is small and cannot
account for the lack of empirical relation. Importantly, this paper demonstrates that failing to
include uncertainty is not responsible for this lack of predictability.10
While for parsimony the original long-run risks model only includes one stochastic
volatility variable, in the model it is the long-run, rather than short-run volatility that matters for
financial markets. Next I empirically examine whether the interest rate appears to move more
with short or long-term uncertainty and, consistent with the long-run risks model, find that the
slower moving long-term uncertainty appears to be the dominant channel.
Similar to Bansal, Kiku, Shaliastovich and Yaron (2014), I examine short-term economic
uncertainty using the variance of month-to-month industrial production growth over the calendar
year t+1. For the long-run measure I examine the variance of month-to-month industrial
production growth over the years t+1 to t+10. I utilize industrial production as it is available
monthly with a time-series that includes the entire baseline analysis period.
To examine whether the interest rate has a stronger relation with long-run or short-run
volatility I undertake a similar exercise as before, but allow for long run and short run
uncertainty to each to have a separate impact. Specifically I run regressions of the form:

10
While an elasticity of intertemporal substitution greater than one is key to the model, some papers have provided
evidence against this assumption (for example Beeler and Campbell (2012), Hall (1988), Campbell (2003)). For the
long-run risks model to yield this negative relation, the elasticity of intertemporal substitution must be greater than
one. Thus, within the context of the long-run risks model, the results in this paper are consistent with an elasticity of
intertemporal substitution greater than one.

23
 𝑟𝑡 = 𝛽0 + 𝛽1 𝐸𝑡 [𝑔𝑡+1 ] + 𝛽2 𝐸𝑡 [𝑆ℎ𝑜𝑟𝑡 − 𝑅𝑢𝑛 𝑈𝑛𝑐𝑒𝑟𝑡𝑎𝑖𝑛𝑡𝑦]
(14)
+ 𝛽3 𝐸𝑡 [𝐿𝑜𝑛𝑔 − 𝑅𝑢𝑛 𝑈𝑛𝑐𝑒𝑟𝑡𝑎𝑖𝑛𝑡𝑦]
In the analysis I utilize three different methods to create ex-ante uncertainty measures. First I
simply utilize the ex-post realized values. Next I utilize lagged values of uncertainty to predict
future by estimating:
[𝐿𝑜𝑛𝑔 − 𝑅𝑢𝑛 𝑈𝑛𝑐𝑒𝑟𝑡𝑎𝑖𝑛𝑡𝑦]𝑡+1;𝑡+10
(15)
= 𝜑𝑔[𝐿𝑜𝑛𝑔 − 𝑅𝑢𝑛 𝑈𝑛𝑐𝑒𝑟𝑡𝑎𝑖𝑛𝑡𝑦]𝑡−9;𝑡 + 𝜀𝑡+1
[𝑆ℎ𝑜𝑟𝑡 − 𝑅𝑢𝑛 𝑈𝑛𝑐𝑒𝑟𝑡𝑎𝑖𝑛𝑡𝑦]𝑡+1
(16)
= 𝜑𝑔[𝑆ℎ𝑜𝑟𝑡 − 𝑅𝑢𝑛 𝑈𝑛𝑐𝑒𝑟𝑡𝑎𝑖𝑛𝑡𝑦]𝑡 + 𝜀𝑡+1
Finally, I also include the macro variables used to predict uncertainty from Bansal, Kiku,
Shaliastovich and Yaron (2014). Specifically I add the year t values of consumption growth,
growth in real per-capita personal income, the price to dividend ratio and return on the S&P 500
to Equations 15 and 16.
Table 13 Panel A presents regressions as described by Equation 14 utilizing ex-post
outcomes as the right hand side variables. Column 1 shows regressions with only the short term
uncertainty measure and finds a negative coefficient that is marginally significant. Column 2
uses the long-run measure and the coefficient increases and becomes much more significant with
a t-statistic of -3.95. Further the R2 increases from 0.05 to 0.34. The third column includes both
measures of uncertainty. After both are included the long-run measure retains its magnitude and
significance, but the short-term uncertainty term switches sign and becomes insignificant with a
t-statistic of 1.34. Thus the real risk free rate seems to predict long-term rather than short-term
shifts in volatility.
The results in Panel A are ex-post realizations and could not be forecast at the time. Panel
B and C utilize time-series models to predict the uncertainty estimates. In Panel B lagged values
as described by Equation 15 and Equation 16 are used to predict the short and long-run
uncertainty. In Panel C macro variables are added to these models in order to predict short-run
and long-run uncertainty. Both Panel B and Panel C yield materially similar results to Panel A. It
appears the robust relation between uncertainty and the interest rate is driven by slow-moving
long-run volatility of growth rather than short-run fluctuations.

24
9. Conclusion
Theory predicts that there is a relation between the interest rate, economic uncertainty
and economic growth. This paper demonstrates this relation empirically and shows that
economic uncertainty has a strong relation with the risk free interest rate. This relation holds
using a variety of specifications, datasets and models. The results imply that analyses of the
relation between interest rates and growth that leave out uncertainty may be seriously
incomplete.

25
References
Amihud, Yakov and Clifford M. Hurvich, 2004. “Predictive Regressions: A Reduced-Bias Estimation Method.”
Journal of Financial and Quantitative Analysis, 813-841.
Amihud, Yakov, Clifford M. Hurvich and Yi Wang, 2009. “Multiple-Predictor Regressions: Hypothesis Testing.”
Review of Financial Studies, 22, 414-434.
Avramov, Doron, Laurent Barras and Robert Kosowski, 2012. “Hedge Fund Return Predictability Under the
Magniying Glass.” Journal of Financial and Quantitative Analysis, Forthcoming.
Bansal, Ravi, Varoujan Khatchatrian and Amir Yaron, 2005. “Interpretable Asset Markets?” European Economic
Review, 49, 531-560.
Bansal, Ravi, Dana Kiku, Ivan Shaliastovich and Amir Yaron, 2014. “Volatility, the macroeconomy, and asset
prices.” The Journal of Finance, 69, 2471-2511.
Bansal, Ravi, Dana Kiku, and Amir Yaron, 2007. “Risks for the Long Run: Estimation and Inference.”
Unpublished Paper.
Bansal, Ravi, Dana Kiku, and Amir Yaron, 2012. “An Empirical Evaluation of the Long-Run Risks Model for
Asset Prices.” Critical Finance Review, 1, 183-221.
Bansal, Ravi and Ivan Shaliastovich, 2013. "A Long-Run Risks Explanation of Predictability Puzzles in Bond and
Currency Markets." Review of Financial Studies 26, 1-33.
Bansal, Ravi and Amir Yaron, 2004. “Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles.”
The Journal of Finance, 59, 1481-1509.
Barro, Robert, and José Ursúa, 2008. “Macroeconomic crises since 1870.” No. w13940. National Bureau of
Economic Research.
Beeler, Jason and John Campbell, 2012. “The Long-Run Risks Model and Aggregate Asset Prices: An Empirical
Assessment.” Critical Finance Review, 1, 141-282.
Bekaert, Geert, 1996. "The time variation of risk and return in foreign exchange markets: A general equilibrium
perspective." Review of Financial Studies 9, 427-470.
Bekaert, Geert, and Eric Engstrom, 2009. “Asset return dynamics under bad environment good environment
fundamentals.” No. w15222. National Bureau of Economic Research.
Bloom, Nicholas, 2009. "The impact of uncertainty shocks." econometrica 77, 623-685.
Bloom, Nicholas, Max Floetotto, Nir Jaimovich, Itay Saporta-Eksten, and Stephen J. Terry, 2010. “Really uncertain
business cycles.” Working Paper.
Boguth, Oliver, and Lars‐Alexander Kuehn, 2013. "Consumption volatility risk." The Journal of Finance 68, 2589-
2615.
Bollerslev, Tim, 1986. “Generalized Autoregressive Conditional Heteroscedasticity.” Journal of Econometrics, 31,
307-327.
Campbell, John, 2003. “Consumption Based Asset Pricing.” Handbook of the Economics of Finance, George
Constantinides, M. Harris and Rene Stultz eds., Vol IB, 803-887.
Campbell, John Y. and John H. Cochrane, 1995. “By Force of Habit: A Consumption-Based Explanation of
Aggregate Stock Market Behavior.” NBER Working Paper, 4995.
Campbell, John Y. and John H. Cochrane, 1999. “By Force of Habit: A Consumption-Based Explanation of
Aggregate Stock Market Behavior.” Journal of Political Economy, 107, 205-251.
Campbell, John Y., and N. Gregory Mankiw, 1989. "Consumption, income and interest rates: Reinterpreting the
time series evidence." NBER Macroeconomics Annual 1989, Volume 4. MIT Press. 185-246.
Carroll, Christopher D., Jeffrey C. Fuhrer and David W. Wilcox, 1994. “Does Consumer Sentiment Forecast
Household Spending? If So, Why?” The American Economic Review, 84(5), 1397-1408.
Chapman, David A., 1998. "Habit formation and aggregate consumption." Econometrica 1223-1230.
Chapman, David A., 2002. "Does intrinsic habit formation actually resolve the equity premium puzzle?." Review of
Economic Dynamics 5, 618-645.
Constantinides, George M. and Anisha Gosh, 2012. “Asset Pricing Tests with Long Run Risks in Consumption
Growth.” Review of Asset Pricing Studies, Forthcoming.
Crone, Theodore M., 2003. “A New Look at State Economic Indexes for the States in the Third District.” Business
Review, November/December, 3-14.
Engle, Robert F., 1982. “Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United
Kingdom Inflation.” Econometrica, 50, 987-1007.
Ermolov, Andrey, 2014, “A Unified Theory of Bond and Currency Markets.” Working Paper.
Ferson, Wayne M., 1983. “Expectations of Real Interest Rates and Aggregate Consumption: Empirical Tests.” The
Journal of Financial and Quantitative Analysis, 18, 477-497.

26
Ferson, Wayne M. and Campbell R. Harvey, 1992. “Seasonality and Consumption-Based Asset Pricing.” Journal of
Finance, 47, 511-552.
Ferson, Wayne M., Suresh Nallareddy and Biqin Xie, 2012. “The ‘Out-of-Sample’ Performance of Long-Run Risk
Models.” Journal of Financial Economics, Forthcoming.
Fisher, Irving, 1907. The Rate of Interest: It’s Nature, Determination and Relation to Economic Phenomena, The
Macmillan Company.
Hall, Robert E, 1978. “Stochastic Implications of the Life Cycle Permanent Income Hypothesis: Theory and
Evidence.” Journal of Political Economy, 86, 971-987.
Hall, Robert E, 1988. “Intertemporal Substitution in Consumption.” Journal of Political Economy, 96(2), 339-357.
Hamilton, James D. and Gabriel Perez-Quiros, 1996. “What Do the Leading Indicators Lead?” The Journal of
Business, 69(1), 27-49.
Hansen, Lars Peter and Kenneth J. Singleton, 1983. “Stochastic Consumption, Risk Aversion and the Temporal
Behavior of Asset Returns.” The Journal of Political Economy, 91, 249-265.
Harvey, Campbell R, 1988. “The Real Term Structure and Consumption Growth.” Journal of Financial Economics,
22, 305-333.
Homer, Sidney and Richard Sylla, 2005. A History of Interest Rates, 4th ed.
Howrey, E. Phillip, 2001. “The Predictive Power of the Index of Consumer Sentiment.” Brookings Papers on
Economic Activity, 1, 175-207.
Jagannathan, Ravi and Srikant Marakani, 2011. "Long Run Risks & Price/Dividend Ratio Factors." NBER Working
Paper, 17484.
Justiniano, Alejandro, and Giorgio E. Primiceri, 2008. "The Time-Varying Volatility of Macroeconomic
Fluctuations." The American Economic Review 98, 604.
Kendall, Maurice G., 1954. "Note on bias in the estimation of autocorrelation." Biometrika 41.3-4, 403-404.
Kendrick, John, 1961. Productivity Trends in The United States, Princeton UP.
Kuznets, Simon, 1961. Capital in the American Economy, Princeton UP.
Macauly, Frederick R., 1938. "Some Theoretical Problems Suggested by the Movements of Interest Rates, Bond
Yields and Stock Prices in the United States since 1856." NBER.
Matsusaka, John G. and Argia M. Sbordone, 1995. “Consumer Confidence and Economic Fluctuations.” Economic
Inquiry, 33(2), 296-318.
McNees, Stephen K., 1979. “The Forecasting Record for the 1970s.” New England Economic Review, 1-21.
Merton, Robert, 1980. “On Estimating the Expected Return on the Market: An Exploratory Investigation.” Journal
of Financial Economics, 8, 323-361.
Miron, Jeffrey A. and Christina D. Romer, 1990. “A New Monthly Index of Industrial Production, 1884-1940.” The
Journal of Economic History, 50, 1990.
Nakamura, Emi, Dimitriy Sergeyev and Jon Steinsson, 2014. “Growth-Rate and Uncertainty Shocks in
Consumption: Cross-Country Evidence” Working Paper.
Neely, Christopher J., and David E. Rapach, 2008. "Real interest rate persistence: evidence and implications."
Federal Reserve Bank of St. Louis Working Paper Series.
Newey, Whitney K. and Kenneth D. West, 1987. “A Simple, Positive Semi-Definite, Heteroskedasticity and
Autocorrelation Consistent Covariance Matrix.” Econometrica, 55, 703-708.
Nicholls, D.F. and A.L. Pope, 1988. “Bias in the Estimation of Multivariate Autoregressions.” Australian Journal of
Statistics, 30A, 296-309.
Otrok, Christopher, B. Ravikumar, and Charles H. Whiteman, 2002. "Habit formation: a resolution of the equity
premium puzzle?." Journal of Monetary Economics 49, 1261-1288.
Romer, Christina D., 1989. “The Prewar Business Cycle Reconsidered: New Estimates of Gross National Product,
1869-1908.” Journal of Political Economy, 97, 1-37.
Shiller, Robert J., 1982. “Consumption, Asset Markets and Economic Fluctuations,” NBER Working Paper, 838.
Shiller, Robert J., 1989. Market Volatility, MIT Press.
Stambaugh, Robert. 1999. “Predictive Regressions.” Journal of Financial Economics, 54, 375-421.
Stock, James H. and Mark W. Watson, 1989. “New Indexes of Coincident and Leading Economic Indicators.”
NBER Macroeconomics Annual, 351-393.
Stock, James H. and Mark W. Watson, 1991. “A probability model of the coincident economic indicators.” in: G.
Moore and K. Lahiri, eds., The Leading Economic Indicators: New Approaches and Forecasting Records
(Cambridge University Press, Cambridge) 63-90.
Verdelhan, Adrien, 2010. "A Habit‐Based Explanation of the Exchange Rate Risk Premium." The Journal of
Finance 65, 123-146.

27
Wachter, Jessica A., 2006. “A Consumption Based Model of the Term Structure of Interest Rates.” Journal of
Financial Economics, 79, 365-399.

Appendix A

Consider a simple discrete time representative agent model with conditionally lognormal
disturbances (as in Hansen and Singleton (1983), Ferson (1983) and Harvey (1988)). The
lognormal disturbances allow a closed form solution to be obtained. Conditional lognormality
allows for heteroskedasticity as a function of the conditioning information. The consumer
receives an endowment and chooses to consume it or invest $Pi,j in one of i=1,…,n securities
with j=1,…k maturities. Ct is consumption at time t and the subscript of the conditional
expectation indicates the time of the information the agent conditions on. The consumer’s
problem is:
∞

max ∞
∑ 𝛿 𝑡 𝐸0 [𝑈(𝐶𝑡 )] (1)
{𝐶𝑡 ,{𝑃𝑖,𝑗,𝑡 }}
𝑡=0 𝑡=0

This yields the first order conditions (FOC):

𝑈′(𝐶𝑡+𝑗 )
𝐸𝑡 [𝛿 𝑗 (1 + 𝑅𝑖,𝑗,𝑡 ) − 1] = 0 (2)
𝑈′(𝐶𝑡 )
For each i,j security, where Ri,j,t is the real return on asset i over j periods from t to t+j.11 Now let
utility take the form:
𝐶 1−𝛼 − 1
𝑈(𝐶, 𝛼) = { 1−𝛼 𝑖𝑓 𝛼 > 1 (3)
𝑙𝑛(𝐶) 𝑖𝑓 𝛼 = 1
Substituting the utility function into the FOC and then taking logs yields:

𝑗
𝐶𝑡+𝑗 −𝛼
𝑙𝑛 (𝐸𝑡 [𝛿 { } (1 + 𝑅𝑖,𝑗,𝑡 )])
𝐶𝑡
𝐶𝑡+𝑗 −𝛼
𝑗
1 𝑗
𝐶𝑡+𝑗 −𝛼 (4)
= 𝐸𝑡 [𝛿 { } (1 + 𝑅𝑖,𝑗,𝑡 )] + 𝑉𝑎𝑟𝑡 [𝛿 { } (1 + 𝑅𝑖,𝑗,𝑡 )]
𝐶𝑡 2 𝐶𝑡
=0
Re-arranging this equation, solving for the interest rate and assuming it is risk free (i.e. known at
time t) yields:

11
Section 2.3 examines issues surrounding the real vs. nominal interest rates and inflation in more detail.

28
 𝐶𝑡+𝑗 𝛼2 𝐶𝑡+𝑗
𝑙𝑛(1 + 𝑅𝑖,𝑗,𝑡 ) = −𝑗𝑙𝑛(𝛿) + 𝛼𝐸𝑡 [𝑙𝑛 ( )] − 𝑉𝑎𝑟𝑡 [𝑙𝑛 ( )] (5)
𝐶𝑡 2 𝐶𝑡

Using external habit formation from Campbell and Cochrane (1999) the specification of the risk
free rate becomes:
𝐶𝑡+𝑗
𝑙𝑛(1 + 𝑅𝑖,𝑗,𝑡 ) = −𝑗𝑙𝑛(𝛿) + 𝛼𝐸𝑡 [𝑙𝑛 ( )]
𝐶𝑡
(1)
𝛼2 𝐶𝑡+𝑗 2
− 𝑉𝑎𝑟𝑡 [𝑙𝑛 ( )] (1 + 𝜆(𝑠𝑡 )) − 𝛼(1 − 𝜙)(𝑠𝑡 − 𝑆̅)
2 𝐶𝑡

where st is the log of the surplus to consumption ratio and λ(st) is the sensitivity function.
Campbell and Cochrane Campbell (1999) specify λ(st) so that the last two terms offset, yielding
the interest rate:
𝐶𝑡+𝑗 1 𝛼 2 𝐶𝑡+𝑗
𝑙𝑛(1 + 𝑅𝑖,𝑗,𝑡 ) = −𝑗𝑙𝑛(𝛿) + 𝛼𝐸𝑡 [𝑙𝑛 ( )] − ( ) 𝑉𝑎𝑟𝑡 [𝑙𝑛 ( )] (2)
𝐶𝑡 2 𝑆̅ 𝐶𝑡

Thus again this is simply a linear combination of expected growth and the variance of expected

growth and can be expressed in the form of Equation 1. In the original model expected growth

and the variance are constant, so the risk free rate is constant.

Another class of models that has a received much attention in recent years is the long-run

risks models introduced in Bansal and Yaron (2004). Constantinides and Gosh (2012) show that

the risk free rate can be written as:

𝑙𝑛(1 + 𝑅𝑖,𝑗,𝑡 ) = 𝐴0,𝑓 + 𝐴1,𝑓 𝑥𝑡 + 𝐴2,𝑓 𝜎𝑡2 (3)

Where A0,f, A1,f and A2,f, are time invariant parameters (see Constantinides and Gosh (2012)
Appendix A2.2 for explicit definitions), xt is the latent state variable and σt is the variance of the
state variable’s innovation. Using the fact that:
𝐶𝑡+𝑗
𝐸𝑡 [𝑙𝑛 ( )] = 𝑥𝑡 + 𝜇𝑐 (4)
𝐶𝑡
Where μc is a constant, and defining the constant Af=A0,f+A1,f μc one can write:

29
 𝐶𝑡+𝑗 𝐶𝑡+𝑗
𝑙𝑛(1 + 𝑅𝑖,𝑗,𝑡 ) = 𝐴𝑓 + 𝐴1,𝑓 𝐸𝑡 [𝑙𝑛 ( )] − 𝐴2,𝑓 𝑉𝑎𝑟𝑡 [𝑙𝑛 ( )] (5)
𝐶𝑡 𝐶𝑡
Thus the long-run risks model also is consistent with Equation 1.

Appendix B

The implementation of the mARM procedure (Amihud, Hurvich and Wang (2009)) in

this paper follows closely to that described in Amihud and Hurvich (2004), the appendix of

Avramov, Barras and Kosowski (2012) and the appendix of Ferson, Nallareddy and Xie (2012).

Denote {xt} as a p-dimensional vector of predictors from t=0,…,T, where for this paper

p=2 and includes forecasts of growth and uncertainty. Also, to make the notation consistent with

Amihud, Hurvich and Wang, xt denotes the forecast made using data at time t for period t+1.

Further rt denotes the interest rate from t-1 to t. The model is thus given by:

𝑟𝑡 = 𝛼 + 𝛽 ′ 𝑥𝑡−1 + 𝑢𝑡 (6)

𝑥𝑡 = 𝛩 + 𝛷𝑥𝑡−1 + 𝜈𝑡 (7)
𝑥1𝑡 𝛩 𝛽 𝜈1𝑡 𝛷 𝛷12
𝑥𝑡 = [𝑥 ] , 𝛩 = [ 1 ] , 𝛽 = [ 1 ] , 𝜈𝑡 = [𝜈 ] , 𝛷 = [ 11 ] (8)
2𝑡 𝛩2 𝛽2 2𝑡 𝛷21 𝛷22
Amihud and Hurvich (2004) show that one can write:

𝑢𝑡 = 𝜙′ 𝜈𝑡 + 𝑒𝑡 (9)

So the model with bias correction to be estimated is:

𝑟𝑡 = 𝛼 + 𝛽 ′ 𝑥𝑡−1 + 𝜙′ 𝜈𝑡 + 𝑢𝑡 (10)

In order to implement the estimate the following procedure is used. Estimate the expression for

̂ and 𝛩̂
xt utilizing a VAR(1) regression.12 This expression yields the preliminary estimate, 𝛷

12
If the initial VAR model is non-stationary the Yule-Walker estimator is used
−1
𝛷 𝑌𝑊 = [∑𝑇𝑡=1(𝑥𝑡 − ̅̅̅
̂ 𝑥∗ )(𝑥𝑡−1 − ̅̅̅
𝑥∗ )′][∑𝑇𝑡=0(𝑥𝑡 − ̅̅̅
𝑥∗ )(𝑥𝑡 − ̅̅̅
𝑥∗ )′]
1
where ̅̅̅
𝑥∗ = 𝑛+1 ∑𝑇𝑡=0 𝑥𝑡

30
along with the covariance matrix from the residuals 𝜈𝑡 denoted 𝛴̂𝑣 . To estimate the small sample

bias, the Nicholls and Pope (1988) estimate is used:

̂ (𝛷
𝑏𝑖𝑎𝑠 ̂ ) = 𝐸[𝛷
̂ − 𝛷]

2
1 (11)
̂ ′)−1 + 𝛷′(𝐼 − 𝛷
= 𝛴̂𝑣 [(𝐼 − 𝛷 ̂ ′2 )−1 + ∑ 𝜆𝑗 (𝐼 − 𝜆𝑗 𝛷
̂ ′)−1 ] 𝛴̂𝑥
𝑇
𝑗=1

̂ and 𝛴̂𝑥 is estimated using the

Where I is a 2x2 identity matrix, 𝜆𝑗 is the jth eigenvalue of 𝛷

formula 𝑣𝑒𝑐(𝛴̂𝑥 ) = [𝐼4 − (𝛷 ⊗ 𝛷)]−1 𝑣𝑒𝑐(𝛴̂𝑣 ).

̂0 ), an iterative procedure is used to construct

Using these initial estimates (denoted 𝛷

̂1 = 𝛷
estimates as follows. The new estimate of coefficients is 𝛷 ̂ (𝛷
̂0 − 𝑏𝑖𝑎𝑠 ̂0 ), the new estimate

of the constant is 𝛩̂1 = (𝐼 − 𝛷

̂1 )𝑍̅ (where 𝑍̅ is the sample mean), and a new estimate of 𝛴̂𝑣 is

obtained from the residuals. If the model is non-stationary the iterations stop and values from

that iteration are used. If not, the procedure repeats itself using the previous steps and estimates

to construct the next iteration for a maximum of 10 iterations. Taking the final values from this

procedure Equation 9 is estimated.

To construct test statistics, the variance of 𝛽̂ is calculated where all terms with hats are

the estimates from the final round of the iteration:

2 2 2
2
̂ (𝛽̂𝑗 ) = ∑(̂
𝑣𝑎𝑟 𝜙𝑖 ) 𝑣𝑎𝑟 ̂𝑖𝑗 ) + ∑ ∑ 2𝜙
̂ (𝛷 ̂𝑖 ̂ ̂𝑖𝑗 , 𝛷
𝜙𝑗 𝑐𝑜𝑣(𝛷 ̂(𝛽̂𝑗 )
̂𝑘𝑗 ) + 𝑆𝐸 (12)
𝑖=1 𝑖=1 𝑘≠𝑖

̂ (β̂j ) is the OLS standard error from the augmented regression of Equation 9. To
Where SE

implement the t-test the test statistic is calculated as:

𝛽̂𝑗
𝑡=
(13)
̂ (𝛽̂𝑗 )
√𝑣𝑎𝑟

31
 Figure 1 - Expected Consumption Growth and 3 Month Treasury Rate

This Figure presents the real 3 month treasury bill rate in year t on forecasts of the log of one plus expected
economic growth in year t+1 using data from 1934 until 2010. Growth is measured by NIPA consumption,
Forecasts are made from an ARMA(1,1)-GARCH(1,1) time series model.

Figure 2 - Ex-Ante Variance of Consumption Growth and 3 Month Treasury Rate

This Figure presents the real 3 month treasury bill rate in year t on forecasts of the log of the variance of
growth in year t+1 using data from 1934 until 2010. Growth is measured by NIPA consumption, Forecasts
are made from an ARMA(1,1)-GARCH(1,1) time series model.

32
 Figure 3 - Historic Consumption Growth

This figure graphs the log of one plus consumption growth from 1890 to 2010.

33
 Figure 4 – Expert and Time Series Forecasts

This figure plots forecasts of the log of one plus expected economic growth from time series models and
from expert forecasts. Growth is measured by NIPA consumption, GDP and industrial production
respectively. The time-series model line shows forecasts from an ARMA(1,1)-GARCH(1,1). The Expert
line plots the median forecast of growth from the Survey of Professional Forecasters.

34
 Table 1
Summary Statistics
Panel A- Measures of Growth Rates
25th 75th
Mean First Year Last Year Std. Dev. Min Pctile Median Pctile Max
Consumption 0.018 1930 2010 0.022 -0.080 0.010 0.021 0.031 0.073
GDP 0.021 1930 2010 0.049 -0.146 0.002 0.023 0.043 0.158
Industrial Production 0.020 1920 2010 0.096 -0.282 -0.008 0.027 0.069 0.228
Historic Consumption 0.020 1890 1929 0.044 -0.085 -0.010 0.018 0.050 0.099
Historic GDP 0.038 1871 1929 0.035 -0.043 0.014 0.038 0.058 0.152
Historic Industrial Production 0.038 1885 1940 0.127 -0.351 -0.015 0.046 0.123 0.374
Panel B - Nominal Annualized Interest Rates
25th 75th
Mean First Year Last Year Std. Dev. Min Pctile Median Pctile Max
3 Month 0.040 1935 2010 0.032 0.000 0.012 0.037 0.057 0.160
30 Day 0.036 1927 2010 0.031 0.000 0.010 0.033 0.054 0.156
6 Month 0.049 1871 2010 0.028 0.003 0.032 0.049 0.061 0.172
1 Year 0.052 1947 2010 0.033 0.004 0.028 0.049 0.073 0.161
This table presents summary statistics for the data analyzed in this paper. Panel A presents summary statistics for the various measures of the log of one
plus economic growth, and Panel B presents summary statistics of the log of nominal interest rates.
 Table 2
Regression of Real Interest Rate on Forecasts of Growth and Uncertainty
Panel A - Residual Methodology

Industrial
Consumption GDP Production
Et[gt+1] -0.573 -0.127 -0.429
(-0.75) (-0.91) (-1.43)
Vart[gt+1] -23.906 -8.161 -1.002
(-3.01) (-8.14) (-1.98)
Constant 0.024 0.020 0.023
(1.47) (3.36) (2.44)
Observations 75 75 75
Adjusted R2 0.08 0.42 0.15
2
R Excluding Vart[gt+1] -0.01 -0.01 0.00
Impact of 1 SD Vart[gt+1] -0.010 -0.020 -0.012
Panel B - GARCH Methodology
Industrial
Consumption GDP Production
Et[gt+1] -0.834 0.239 0.049
(-0.88) (1.14) (0.20)
Vart[gt+1] -60.389 -12.902 -2.441
(-3.30) (-11.22) (-3.04)
Constant 0.038 0.020 0.020
(1.72) (3.03) (3.72)
Observations 76 76 76
Adjusted R2 0.14 0.55 0.35
2
R Excluding Vart[gt+1] 0.00 -0.01 0.00
Impact of 1 SD Vart[gt+1] -0.012 -0.023 -0.018
This table presents regressions of the 3 month treasury bill rate in year t on forecasts of the log of one plus
expected economic growth and the variance of the growth in year t+1 using data from 1934 until 2010.
Growth is measured by NIPA consumption, GDP and industrial production respectively. In panel A
forecasts of growth are made from an ARMA(1,1) model and the variance of growth is the square of the
lagged residual. In Panel B forecasts are made from an ARMA(1,1)-GARCH(1,1) time series model. The
row labeled "Impact of 1 SD Vart[gt+1]" is the standard deviation of the variance of growth multiplied by
the coefficient on the variance of growth. Standard errors are Newey West using 3 lags. The top value is the
coefficient, the lower value in parentheses is the t-statistic.
 Table 3
Regression of Real Interest Rate on Forecasts of Growth and Uncertainty
Winsorised at 90th Percentile and using Ex-Post Realized Growth
Industrial
Consumption GDP Production
Et[gt+1] -0.681 0.422 -0.146
(-0.78) (1.04) (-0.56)
Vart[gt+1] -126.189 -17.249 -3.638
(-3.34) (-7.05) (-5.39)
Constant 0.046 0.019 0.028
(2.09) (2.00) (4.40)
Observations 76 76 76
Adjusted R2 0.17 0.44 0.44
2
R Excluding Vart[gt+1] -0.01 0.00 -0.01
Impact of 1 SD Vart[gt+1] -0.013 -0.020 -0.020
This table presents regressions of the 3 month treasury bill rate in year t on forecasts of the log of one plus
expected economic growth and the variance of the growth in year t+1 using data from 1934 until 2010.
Growth is measured by NIPA consumption, GDP and industrial production respectively. Growth and
uncertainty forecasts are winsorised at the 90th percentile. Forecasts are made from an ARMA(1,1)-
GARCH(1,1) time series model. The row labeled "Impact of 1 SD Var t[gt+1]" is the standard deviation of
the variance of growth multiplied by the coefficient on the variance of growth. Standard errors are Newey
West using 3 lags. The top value is the coefficient, the lower value in parentheses is the t-statistic.

37
 Table 4
Regression of the Real Interest Rate on Forecasts of Growth and Uncertainty Using Historic Data
Consumption GDP Industrial Production
1890-2010 1871 - 2010 1895 - 2010

No Winsorised No Winsorised No Winsorised

Correction 90% Correction 90% Correction 90%
Et[gt+1] 0.098 0.367 0.100 0.560 0.648 0.938
(0.18) (0.49) (0.28) (1.26) (2.19) (2.23)
Vart[gt+1] -6.150 -7.813 -6.262 -8.734 -1.487 -1.697
(-1.53) (-1.68) (-2.20) (-2.41) (-2.47) (-2.62)
Constant 0.026 0.022 0.034 0.026 0.024 0.021
(1.86) (1.16) (3.58) (2.24) (3.20) (2.11)
Observations 121 121 140 140 126 126
Adjusted R2 0.02 0.03 0.11 0.13 0.15 0.16
2
R Excluding Vart[gt+1] -0.01 0.00 -0.01 0.00 0.01 0.01
Impact of 1 SD Vart[gt+1] -0.005 -0.006 -0.011 -0.012 -0.011 -0.012
This table presents regressions of the 3 month treasury bill rate in year t on forecasts of the log of one plus expected economic growth and the variance
of the growth in year t+1. Growth is measured by consumption (1890-2010), GDP (1871-2010) and industrial production (1895-2010) respectively.
Columns labeled "No Correction" use the raw forecasts while columns labeled "Winsorised 90%" winsorise the forecasts at the 90th percentile.
Forecasts are made from an ARMA(1,1)-GARCH(1,1) time series model. The row labeled "Impact of 1 SD Vart[gt+1]" is the standard deviation on the
variance of growth multiplied by the coefficient on the variance of growth. Standard errors are Newey West using 3 lags. The top value is the
coefficient, the lower value in parentheses is the t-statistic.
 Table 5
Quarterly Regression of the Real Interest Rate
on Forecasts of Growth and Uncertainty
Industrial
Consumption GDP Production
Et[gt+1] 0.086 0.062 0.019
(0.93) (0.70) (0.46)
Vart[gt+1] -64.377 -29.851 -14.882
(-3.30) (-1.56) (-5.20)
Constant 0.011 0.013 0.021
(2.15) (1.96) (6.36)
Observations 256 256 256
Adjusted R2 0.08 0.02 0.26
2
R Excluding Vart[gt+1] 0.01 0.00 0.00
Impact of 1 SD Vart[gt+1] -0.008 -0.005 -0.015
This table presents regressions of the 3 month treasury bill rate in year t on forecasts of the log of one plus
expected economic growth and the variance of the growth in year t+1 using data from 1947 until 2010.
Growth is measured by NIPA consumption, GDP and industrial production respectively. Forecasts are
made from an ARMA(1,1)-GARCH(1,1) time series model. The growth rate is annual and the interest rate
is annualized. The row labeled "Impact of 1 SD Var t[gt+1]" is the standard deviation on the variance of
growth multiplied by the coefficient on the variance of growth. Standard errors are Newey West using 4
lags. The top value is the coefficient, the lower value in parentheses is the t-statistic.
 Table 6
Regression of Real Interest Rate on Forecasts of Growth and Uncertainty for Countries Outside the US
Panel A - Consumption
Belgium Canada France Germany Italy Japan Netherlands UK
Et[gt+1] 0.7804 0.0453 -0.3590 0.3940 1.4501 0.8698 -0.0630 1.0797
(1.40) (0.06) (-0.91) (1.64) (2.40) (3.91) (-2.94) (3.98)
Vart[gt+1] -0.8067 -19.6832 -6.5062 -125.5366 -31.3694 -35.5100 -0.3447 -0.0002
(-0.03) (-3.91) (-4.21) (-2.07) (-3.77) (-3.72) (-11.64) (-1.85)
Constant 0.0138 0.0189 0.0256 0.0327 -0.0332 -0.0025 0.0059 -0.0056
(0.99) (0.97) (2.07) (3.30) (-1.47) (-0.45) (0.96) (-0.88)
Observations 61 75 49 56 69 49 68 109
Adjusted R2 0.00 0.14 0.08 0.12 0.31 0.40 0.27 0.16
2
R Excluding Vart[gt+1] 0.01 -0.01 0.03 -0.02 0.02 0.03 0.05 0.17
Impact of 1 SD Vart[gt+1] 0.000 -0.013 -0.008 -0.007 -0.083 -0.018 -0.015 -0.001
Panel B - GDP
Belgium Canada France Germany Italy Japan Netherlands UK
Et[gt+1] 1.0901 -0.1262 -0.3438 0.4309 2.7429 0.5538 -0.0025 -0.1502
(4.66) (-0.50) (-1.13) (1.56) (3.02) (4.69) (-0.11) (-0.34)
Vart[gt+1] 10.5226 -15.9396 -3.5456 -2.7225 -5.8442 -9.3346 -0.3228 -9.0242
(0.61) (-3.63) (-2.55) (-1.07) (-4.52) (-3.47) (-5.54) (-0.42)
Constant -0.0036 0.0248 0.0243 0.0071 -0.1014 -0.0032 0.0049 0.0198
(-0.55) (2.49) (2.33) (1.11) (-3.01) (-0.65) (0.81) (1.01)
Observations 61 75 49 56 69 49 68 109
Adjusted R2 0.17 0.09 0.07 0.00 0.41 0.40 0.19 -0.01
2
R Excluding Vart[gt+1] 0.18 0.02 0.04 0.00 0.18 0.09 -0.01 -0.01
Impact of 1 SD Vart[gt+1] 0.001 -0.011 -0.007 -0.002 -0.077 -0.015 -0.015 -0.003
This table presents This table presents regressions for each country of the 3 month treasury bill rate in year t on forecasts of the log of one plus expected economic growth and the
variance of the growth in year t+1. Growth is measured by consumption and GDP. Forecasts are made from an ARMA(1,1)-GARCH(1,1) time series model for each country. The
row labeled "Impact of 1 SD Vart[gt+1]" is the standard deviation on the variance of growth multiplied by the coefficient on the variance of growth. Standard errors are Newey
West using 3 lags. The top value is the coefficient, the lower value in parentheses is the t-statistic.
 Table 7
Regression of Various Interest Rates on Forecasts of Growth and Uncertainty
Panel A - Consumption
30 Day 3 Month 6 Month 1 Year
Et[gt+1] -1.0190 -0.8343 0.7201 -0.5185
(-1.12) (-0.88) (1.05) (-0.30)
Vart[gt+1] -58.8798 -60.3887 -66.2152 -74.9875
(-3.08) (-3.30) (-6.64) (-2.35)
Constant 0.0400 0.0378 0.0143 0.0431
(1.89) (1.72) (0.87) (1.08)
Observations 76 76 76 64
Adjusted R2 0.14 0.14 0.19 0.12
2
R Excluding Vart[gt+1] 0.00 0.00 0.02 0.00
Impact of 1 SD Vart[gt+1] -0.012 -0.012 -0.013 -0.015
Panel B - GDP
30 Day 3 Month 6 Month 1 Year
Et[gt+1] 0.194 0.239 0.213 0.347
(0.93) (1.14) (0.78) (0.77)
Vart[gt+1] -12.799 -12.902 -10.576 -14.331
(-10.61) (-11.22) (-5.73) (-5.18)
Constant 0.019 0.020 0.025 0.025
(3.14) (3.03) (3.45) (2.00)
Observations 76 76 76 64
Adjusted R2 0.56 0.55 0.36 0.45
2
R Excluding Vart[gt+1] -0.01 -0.01 -0.01 0.15
Impact of 1 SD Vart[gt+1] -0.023 -0.023 -0.019 -0.026
Panel C - Industrial Production
30 Day 3 Month 6 Month 1 Year
Et[gt+1] 0.021 0.049 0.305 0.333
(0.09) (0.20) (1.70) (1.46)
Vart[gt+1] -2.419 -2.441 -2.360 -6.018
(-3.01) (-3.04) (-3.82) (-6.59)
Constant 0.019 0.020 0.024 0.034
(3.74) (3.72) (3.86) (4.29)
Observations 76 76 76 64
Adjusted R2 0.36 0.35 0.31 0.45
2
R Excluding Vart[gt+1] 0.00 0.00 -0.01 -0.01
Impact of 1 SD Vart[gt+1] -0.018 -0.018 -0.018 -0.045
This table presents regressions various interest rates in year t on forecasts of the log of one plus expected economic growth and the
variance of the growth in year t+1 using data from 1934 until 2010. Growth is measured by NIPA consumption, GDP and industrial
production respectively using data from 1934 until 2010. The interest rate used is indicated by the column header. Forecasts are made
from an ARMA(1,1)-GARCH(1,1) time series model. The row labeled "Impact of 1 SD Var t[gt+1]" is the standard deviation on the
variance of growth multiplied by the coefficient on the variance of growth. Standard errors are Newey West to using 3 lags. The top
number is the coefficient, the lower number in parentheses is the t-statistic.
 Table 8
Regression of the Real Interest Rate on Uncertainty, Ex-Post Growth
and Expert Forecasts of Growth
Panel A - Ex-Post Growth
Industrial
Consumption GDP Production
Et[gt+1] 0.1046 0.0572 0.0406
(0.36) (1.17) (1.16)
Vart[gt+1] -56.6577 -12.8533 -2.5723
(-5.04) (-8.68) (-4.16)
Constant 0.0171 0.0234 0.0207
(1.91) (4.95) (3.90)
Observations 76 76 76
Adjusted R2 0.12 0.54 0.35
2
R Excluding Vart[gt+1] 0.00 0.00 0.00
Impact of 1 SD Vart[gt+1] -0.011 -0.023 -0.019
Panel B - Expert Forecasts
Industrial
Consumption GDP Production
Ei,t[gt+1] 0.144 -0.084 -0.002
(0.91) (-0.70) (-0.03)
Vart[gt+1] -56.619 -5.672 -5.446
(-5.74) (-0.52) (-4.30)
Constant 0.025 0.022 0.030
(4.78) (3.44) (6.76)
Observations 2,955 4,856 4,710
Number of Years 29 42 42
Adjusted R2 0.19 0.01 0.11
2
R Excluding Vart[gt+1] 0.03 0.00 0.00
Impact of 1 SD Vart[gt+1] -0.011 -0.010 -0.041
 Panel C - Rolling Forecasts
Industrial
Consumption GDP Production
Et[gt+1] 0.8737 -0.0072 0.0818
(1.80) (-0.02) (0.54)
Vart[gt+1] -2.6771 -0.4375 -0.8540
(-4.26) (-0.48) (-5.14)
Constant -0.0034 0.0162 0.0160
(-0.27) (1.70) (2.18)
Observations 60 60 60
Adjusted R2 0.16 -0.03 0.10
2
R Excluding Vart[gt+1] -0.01 -0.02 -0.01
Impact of 1 SD Vart[gt+1] -0.013 -0.001 -0.008
Panel A contains regressions as described in Table 2, but the realized ex-post value for growth is used.
Panel B presents panel regressions by year and individual expert forecast. The log of one plus the nominal
3 month treasury bill rate in year t minus the expert forecast of inflation is regressed on forecasts of the log
of one plus growth and the variance of the growth in year t+1 (calculated from an ARMA(1,1)-
GARCH(1,1) model) using data from 1982 until 2010 for consumption and 1969-2010 for GDP and
industrial production. Standard errors are clustered by year and by expert ID. The top value is the
coefficient, the lower value in parentheses is the t-statistic.

43
 Table 9
VIX Regressions of the Real Interest Rate
on Forecasts of Growth and Uncertainty
Panel A - Newey Regression
Leading Index for the US Consumer Sentiment
Et[gt+1] 0.024 0.012
(0.74) (3.71)
VIX -0.014 -0.011
(-2.18) (-2.81)
Constant 0.012 0.013
(6.35) (13.46)
Observations 246 246
Adjusted R2 0.08 0.21
2
R Excluding VIX 0.09 0.19
Impact of 1 SD VIX -0.001 -0.001
Panel B - mARM Procedure
Leading Index for the US Consumer Sentiment
Et[gt+1] 0.026 0.013
(1.17) (6.46)
VIX -0.018 -0.014
(-2.82) (-3.30)
Residual Et[gt+1] -0.166 -0.012
(-2.64) (-2.06)
Residual Vart[gt+1] 0.012 0.012
(1.30) (1.53)
Constant 0.012 0.014
(7.64) (16.11)
Observations 245 245
Adjusted R2 0.11 0.23
Impact of 1 SD VIX -0.001 -0.001
This table presents regressions of the 3 month treasury bill rate in year t on growth forecasts measured by
the variable indicated in the column header and variance measured by the VIX index using data from 1990
until 2010. Growth Measures are in logs. In Panel A newey-west regressions are run with 3 lags. In Panel B
the mARM persistence correction is used. Standard errors in Panel B for the coefficients on E t[gt+1] and
Vart[gt+1] are mARM corrected and all others are White robust errors. The top value is the coefficient, the
lower value in parentheses is the t-statistic.

44
 Table 10
Controlling for Inflation Risk in Regression of the Real Interest Rate
on Forecasts of Growth and Uncertainty
Panel A: Inflation Risk from Time Series Model
Industrial
Consumption GDP Production
Et[gt+1] -1.492 0.524 0.247
(-1.24) (1.44) (0.67)
Vart[gt+1] -53.782 -15.075 -2.005
(-1.75) (-4.78) (-1.90)
Vart[i t+1] -13.995 5.224 -4.097
(-3.04) (0.79) (-0.93)
Covt[gt+1,i t+1] 132.277 -22.711 -14.038
(2.01) (-1.04) (-1.04)
Constant 0.082 0.009 0.016
(2.26) (0.89) (2.22)
Observations 76 76 76
Adjusted R2 0.10 0.44 0.18
Impact of 1 SD Vart[gt+1] -0.011 -0.027 -0.015
Panel B: Inflation Risk as Variance of Expert Inflation Forecasts
Industrial
Consumption GDP Production
Et[gt+1] 0.222 -0.086 0.004
(1.40) (-0.72) (0.07)
Vart[gt+1] -63.389 -4.928 -6.574
(-5.22) (-0.40) (-4.18)
Vart[i t+1] 2.350 -8.063 32.892
(3.52) (-0.21) (0.92)
Constant 0.009 0.023 0.029
(1.34) (3.70) (6.51)
Observations 2955 4856 4710
Adjusted R2 0.29 0.01 0.13
Impact of 1 SD Vart[gt+1] -0.013 -0.009 -0.049
This table presents regressions of the 3 month tresury bill rate in year t on forecasts of the log of one plus
expected economic growth and the variance of the growth in year t+1 as well as inflation forecasts using
data from 1934 until 2010. Growth is measured by NIPA consumption, GDP and industrial production
respectively. Forecasts are made from an ARMA(1,1)-GARCH(1,1) time series model. The row labeled
"Impact of 1 SD Vart[gt+1]" is the standard deviation of the variance of growth multiplied by the coefficient
on the variance of growth. Standard errors are Newey West to using 3 lags. The top number is the
coefficient, the lower number in parentheses is the t-statistic.

45
 Table 11
Persistence Tests for Regressions of the Real Interest Rate
on Forecasts of Growth and Uncertainty
Panel A - 5 Year Interval
Industrial
Consumption GDP Production
Et[gt+1] 0.334 0.807 0.894
(0.41) (1.53) (3.12)
Vart[gt+1] -80.626 -11.688 -2.589
(-3.04) (-2.73) (-4.58)
Constant 0.023 0.010 0.013
(1.03) (0.96) (2.02)
Observations 16 16 16
Adjusted R2 0.27 0.31 0.37
2
R Excluding Vart[gt+1] 0.10 0.00 -0.07
Impact of 1 SD Vart[gt+1] -0.016 -0.021 -0.019
Panel B - mARM Procedure
Industrial
Consumption GDP Production
Et[gt+1] -3.274 0.386 0.158
(-1.25) (0.80) (0.34)
Vart[gt+1] -80.070 -12.364 -2.897
(-4.00) (-6.22) (-5.63)
Residual Et[gt+1] 2.562 -0.206 0.074
(0.95) (-0.40) (0.14)
Residual Vart[gt+1] 34.325 -2.674 2.566
(1.87) (-0.86) (2.42)
Constant 0.094 0.016 0.022
(1.70) (1.86) (3.54)
Observations 75 75 75
Adjusted R2 0.17 0.55 0.38
Impact of 1 SD Vart[gt+1] -0.016 -0.022 -0.022
This table presents regressions of the 3 month treasury bill rate in year t on forecasts of the log of one plus
expected economic growth and the variance of the growth in year t+1 using data from 1934 until 2010.
Growth is measured by NIPA consumption, GDP and industrial production respectively. In Panel A one
observations is used every 5 years starting in 1935 through the end of 2010. In Panel B the mARM
persistence correction is used. Forecasts are made from an ARMA(1,1)-GARCH(1,1) time series model.
The row labeled "Impact of 1 SD Vart[gt+1]" is the standard deviation on the variance of growth multiplied
by the coefficient on the variance of growth. Standard errors in Panel B for the coefficients on Et[gt+1] and
Vart[gt+1] are mARM corrected and all others are White robust errors. The top value is the coefficient, the
lower value in parentheses is the t-statistic.

46
 Table 12
Controlling for Surplus Consumption in Regressions of the Real Interest Rate
on Forecasts of Growth and Uncertainty
Panel A - Wachter Replication
Consumption GDP Industrial Production
Surplus Consumption -0.1513 -0.1014 -0.0534
(-1.12) (-4.35) (-2.66)
Constant 0.0355 0.0293 0.0172
(1.44) (4.02) (2.36)
Observations 71 71 76
2
Adjusted R 0.04 0.21 0.12
Panel B - Regression with Consumption Surplus
Consumption GDP Industrial Production
Et[gt+1] -1.2360 0.3387 0.0664
(-0.80) (1.77) (0.30)
Vart[gt+1] -81.8939 -100.8627 -13.5549 -13.6259 -2.1853 -2.2097
(-4.50) (-3.25) (-6.92) (-9.10) (-2.89) (-2.75)
Surplus Consumption -0.1358 -0.0938 0.0197 0.0104 -0.0226 -0.0229
(-1.23) (-0.93) (0.81) (0.47) (-1.03) (-1.05)
Constant 0.0477 0.0695 0.0222 0.0174 0.0241 0.0233
(2.37) (1.91) (3.30) (2.24) (4.03) (3.53)
Observations 71 71 71 71 76 76
Adjusted R2 0.16 0.16 0.57 0.57 0.36 0.36
Impact of 1 SD Vart[gt+1] -0.011 -0.013 -0.024 -0.024 -0.016 -0.017
This table presents regressions of the 3 month tresury bill rate in year t on forecasts of the log of one plus
expected economic growth and the variance of the growth in year t+1 as well as surplus consumption using
data from 1934 until 2010. Growth is measured by NIPA consumption, GDP and industrial production
respectively. Forecasts are made from an ARMA(1,1)-GARCH(1,1) time series model. Panel A presents
regressions of the interest rate on surplus consumption for various measures of growth. Panel B adds
forecasts of growth, uncertainty and inflation. The row labeled "Impact of 1 SD Var t[gt+1]" is the standard
deviation of the variance of growth multiplied by the coefficient on the variance of growth. Standard errors
are Newey West using 3 lags. The top number is the coefficient, the lower number in parentheses is the t-
statistic.

47
 Table 13
Short-Run versus Long-Run Uncertainty
Panel A - Ex-Post
Et[gt+1] -0.1258 0.1533 0.1834
(-0.19) (0.33) (0.41)
Short-Run Uncertainty -16.6555 9.9693
(-1.82) (1.34)
Long-Run Uncertainty -61.5294 -71.8926
(-3.95) (-3.84)
Constant 0.0203 0.0425 0.0416
(1.61) (3.40) (3.37)
Observations 76 76 76
Adjusted R2 0.05 0.34 0.34
Panel B - Time Series
Et[gt+1] -0.2724 0.2042 0.1773
(-0.46) (0.35) (0.31)
Short-Run Uncertainty -38.2951 -3.8336
(-2.43) (-0.24)
Long-Run Uncertainty -54.5604 -52.1692
(-3.03) (-2.47)
Constant 0.0437 0.0397 0.0418
(2.93) (3.31) (2.94)
Observations 76 76 76
Adjusted R2 0.09 0.23 0.22
Panel C - VAR
Et[gt+1] -0.4753 -0.0591 0.1694
(-0.83) (-0.11) (0.28)
Short-Run Uncertainty -29.5304 18.3450
(-2.83) (1.05)
Long-Run Uncertainty -52.2599 -69.8710
(-3.05) (-2.56)
Constant 0.0377 0.0416 0.0349
(2.64) (3.18) (2.46)
Observations 76 76 76
Adjusted R2 0.07 0.18 0.18
This table presents regressions of the 3 month tresury bill rate in year t on forecasts of the log of one plus
expected economic growth and the variance of the growth in year t+1 using data from 1934 until 2010.
Growth is measured by industrial production. Short-term uncertainty is the variance of monthly industrial
production innovations in year t+1 and long term is through year t+10. Forecasts of growth are made from
an ARMA(1,1)-GARCH(1,1) time series model. Panel A uses ex-post observed uncertainty. Panel B
forecasts uncertainty using lagged values of the variables. Panel C repeats the analysis of panel B, but adds
lagged values of consumption growth, the return and price/dividend ration of the S&P 500, and the change
in real per capita disposable income. Standard errors are Newey West using 3 lags. The top number is the
coefficient, the lower number in parentheses is the t-statistic.

48
 Appendix Table 1
Regression of Interest Rates on Measures of Growth and Uncertainty
Panel A - Consumption
January Rolling Over Forecast Ex-Post
Et[gt+1] -0.899 -1.077 -1.676 -0.759
(-0.87) (-1.19) (-1.81) (-0.75)
Vart[gt+1] -65.560 -60.620 -53.205 -64.322
(-3.64) (-2.94) (-2.14) (-3.73)
Constant 0.040 0.043 0.054 0.037
(1.69) (1.97) (2.36) (1.60)
Observations 77 76 77 77
Adjusted R2 0.16 0.15 0.13 0.15
2
R Excluding Vart[gt+1] 0.00 0.00 0.04 -0.01
Impact of 1 SD Vart[gt+1] -0.013 -0.012 -0.010 -0.012
Panel B - GDP
January Rolling Over Forecast Ex-Post
Et[gt+1] 0.260 0.178 -0.052 0.259
(1.27) (0.83) (-0.17) (1.28)
Vart[gt+1] -13.279 -12.823 -11.574 -13.092
(-11.68) (-9.89) (-5.63) (-11.98)
Constant 0.019 0.021 0.024 0.019
(2.83) (3.20) (3.28) (2.84)
Observations 77 76 77 77
Adjusted R2 0.54 0.54 0.41 0.54
2
R Excluding Vart[gt+1] -0.01 -0.01 0.02 -0.01
Impact of 1 SD Vart[gt+1] -0.023 -0.023 -0.020 -0.023
Panel C - Industrial Production
January Rolling Over Forecast Ex-Post
Et[gt+1] 0.073 -0.012 -0.254 0.062
(0.32) (-0.05) (-1.18) (0.28)
Vart[gt+1] -2.357 -2.438 -2.035 -2.311
(-3.02) (-2.99) (-2.66) (-3.01)
Constant 0.019 0.021 0.022 0.019
(3.49) (3.69) (3.59) (3.56)
Observations 77 76 77 77
Adjusted R2 0.33 0.34 0.27 0.32
2
R Excluding Vart[gt+1] 0.00 0.00 0.04 0.00
Impact of 1 SD Vart[gt+1] -0.018 -0.018 -0.016 -0.018
This table presents regressions various interest rates in year t on forecasts of the log of one plus expected economic growth and the
variance of the growth in year t+1 using data from 1934 until 2010. Growth is measured by NIPA consumption, GDP and industrial
production respectively using data from 1934 until 2010. Interest rates used are indicated by the column header. "January" uses the
January interest rate annualized from year t+1. "Rolling Over" uses the interest rate compounded from monnths 3,6,9,12 in year t.
"Forecast" models the interest rate from months 1,4,7,10 as an ARMA(1,1) and uses the prediction for year t. "Ex-Post" uses the
realized interest rate from months 1,4,7,10 in year t+1. Forecasts are made from an ARMA(1,1)-GARCH(1,1) time series model. The
row labeled "Impact of 1 SD Vart[gt+1]" is the standard deviation on the variance of growth multiplied by the coefficient on the
variance of growth. Standard errors are Newey West using 3 lags. The top number is the coefficient, the lower number in parentheses
is the t-statistic.
 Appendix Table 2
Alternative Lag Length Regressions of the Real Interest Rate
on Forecasts of Growth and Uncertainty
Industrial
Consumption GDP Production
AR(1): Vart[gt+1] -80.421 -13.048 -3.182
(-4.19) (-14.69) (-5.35)
MA(1): Vart[gt+1] -102.257 -11.953 -3.113
(-4.33) (-10.17) (-5.15)
ARMA(1,1): Vart[gt+1] -88.060 -13.105 -3.037
(-4.24) (-13.36) (-5.31)
ARMA(2,2): Vart[gt+1] -43.088 -4.140 -2.461
(-4.44) (-2.98) (-4.31)
ARMA(3,3): Vart[gt+1] -60.614 -6.836 -2.935
(-2.89) (-4.78) (-3.94)
ARMA(4,4): Vart[gt+1] -55.377 -6.541 -2.949
(-2.97) (-4.23) (-4.92)
ARMA(5,5): Vart[gt+1] -52.121 -7.391 -3.014
(-2.97) (-4.31) (-4.77)
Observations 71 71 71
This table presents regressions of the 3 month treasury bill rate in year t on forecasts of the log of one plus
expected economic growth and the variance of the growth in year t+1 using data from 1939 until 2010.
Growth is measured by NIPA consumption, GDP and industrial production respectively. Forecasts are
made using the time series model indicated in the left column. Standard errors are Newey West using 3
lags. The top value is the coefficient, the lower value in parentheses is the t-statistic.