Yield spread and the income distribution

The yield spread is known to be closely related with business cycles identified by the National Bureau of Economic Research. It is low near peaks and high near troughs. This paper builds on this known relationship and examines the response of the income distribution in the U.S. due to variation in the yield spread. The purpose is to identify the significance and sign of the impact changes in economic conditions have on the distribution of income over the period 1927–2011. Clark and McCracken's (2001) 1-step ahead encompassing tests from nested linear models are initially estimated to determine the predictive power of the yield spread on the distribution of income. Results strongly reject the null hypothesis that the yield spread has no predictive content for changes in the distribution of income. Specifically, increases in the yield spread are found to correspond with subsequent increases in top income shares.