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The Shadow Rate, Taylor Rules, and Monetary Policy Lift-off

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  • Glenn Rudebusch

    (Federal Reserve Bank of San Francisco)

  • Michael Bauer

    (Federal Reserve Bank of San Francisco)

Abstract

When the policy rate is constrained by the zero lower bound (ZLB), a new set of tools is needed to answer crucial questions about monetary policy, regarding the impact of the ZLB, expected lift-off, and the appropriateness of the policy stance. We document the shortcomings of affine dynamic term structure models (DTSMs) at the ZLB, and the benefits of shadow rate DTSMs. Using these we are able to appropriately answer the questions of interest: First, over recent years U.S. monetary policy has become increasingly constrained by the zero bound. Second, we estimate that in December 2012 the expected duration of the period of near-zero policy rates was 33 months, in line with survey-based and private-sector forecasts. Third, incorporating macroeconomic information in ZLB models is beneficial, improving inference about future policy, and allowing us to derive model-based Taylor rules and the resulting policy prescriptions. We find that in December 2012 the stance of monetary policy was in line with the desired stance based on simple policy rules.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 691.

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Date of creation: 2013
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Handle: RePEc:red:sed013:691

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  1. Leo Krippner, 2011. "Modifying Gaussian term structure models when interest rates are near the zero lower bound," CAMA Working Papers 2011-36, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  2. Andrew Ang & Sen Dong & Monika Piazzesi, 2005. "No-arbitrage Taylor rules," Proceedings, Federal Reserve Bank of San Francisco.
  3. Michael D. Bauer & Glenn D. Rudebusch & Jing Cynthia Wu, 2012. "Correcting Estimation Bias in Dynamic Term Structure Models," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 30(3), pages 454-467, April.
  4. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
  5. Black, Fischer, 1995. " Interest Rates as Options," Journal of Finance, American Finance Association, vol. 50(5), pages 1371-76, December.
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