In this study, we have examined the effect of economic regimes on the relation between the term structure of interest rates and future economic activity in Japan. Specifically, we wished to determine the predictive power of the Japanese term structure on future economic growth under different economic regimes. The Japanese experience offers a unique opportunity to examine this issue, as the country has experienced two distinct economic regimes in its recent past. We found that the term structure successfully predicted future economic growth only in the latter period of our sample (1984–1991), a period of financial market liberalization and interest rate deregulation. The findings emphasize the importance of considering the economic environment in testing the term structure theory.