Shadow short rate and monetary policy in the Euro area

Abstract

Empirical modelling of the monetary policy effects using conventional linear econometric models is put to a great test when interest rates approach the zero-lower bound. A possible remedy recently proposed in the literature is to introduce a shadow short rate (SSR) obtained from the yield curve model as an alternative monetary policy measure. This paper examines the usefulness of shadow rates as a policy stance measure for the Euro area. Moreover, the SSR can be used to study the country-specific monetary policy stance. We incorporate the shadow short rate in a standard vector autoregressive analysis to study the effects of monetary policy shocks both at the level of the Euro area and for two periphery EA countries, Italy and Spain, that endured significant financial stress during the crisis. Our analysis shows that monetary policy shocks identified form the SSR produce similar macro responses as shocks identified from the standard policy rate. The Euro area shocks can directly translate to a corresponding change in the country-specific financing conditions in the periphery, whereas the reverse effect is limited. The historical decomposition of the stochastic component of the SSR series shows that the unconventional policy measures were effective in stabilising the sovereign crisis in 2011, however, their relatively limited quantity provided only a weak stimulus to the economy.

The Spillover Effects of the US Unconventional Monetary Policy: New Evidence from Asian Developing Countries

“…The SSR used in this research was adopted from the measure of Krippner (2016), which incorporated two latent factors. Damjanović and Masten (2016) suggest that, compared to that of Wu and Xia (2016), the estimate of Krippner (2016) is a superior proxy for policy stance. Wu and Xia (2016) also identify another advantage using Krippner's measure: to maintain the stability of the parameters and deliver favorable robustness checks of the choice of the sample period.…”

Volatility Spillovers between Interest Rates and Equity Markets of Developed Economies

“…For example, one approach disregards short rates and only considers interest rates of longer maturities that have remained sufficiently above zero. However, interest rates of longer maturities do not offer a clear interpretation as they may carry other information aside from the stance of monetary policy itself, like changes in the natural rate of interest, inflation expectations, and risk and liquidity premia" as explained by Damjanović and Masten (2016). Other literature also employs the use of the quantity of money to describe monetary policy stance at the ZLB (Damjanović and Masten, 2016).…”

Evaluating the Macroeconomic Effects of the ECB's Unconventional Monetary Policies

“…Moreover, Damjanovic and Masten () estimate a small VAR model, for the euro area, with output, prices, and a shadow rate. They report that an unconventional monetary policy shock that decreases the shadow rate by 100 basis points increases euro‐area output by about 0.7% and increases prices by about 0.2%.…”