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A shadow rate model with time-varying lower bound of interest rates

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  • Kortela, Tomi

Abstract

Typically a constant – or zero – lower bound for interest rates is applied in shadow rate term structure models. However, euro area yield curve data suggest that a time-varying lower bound might be appropriate for the euro area. I show that this indeed is the case, i.e. a shadow rate model with time-varying lower bound outperforms the constant lower bound model in euro area data. I argue that the time-variation in the lower bound is related to the deposit facility rate and, thus, to monetary policy. This time-variation in the lower bound gives a new channel via which monetary policy may affect the yield curve in a shadow rate model. I show that the intensity of this channel depends on how tightly the lower bound restricts the yield curve, and I argue that this channel has recently become important for the euro area.

Suggested Citation

  • Kortela, Tomi, 2016. "A shadow rate model with time-varying lower bound of interest rates," Research Discussion Papers 19/2016, Bank of Finland.
  • Handle: RePEc:bof:bofrdp:2016_019
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    Cited by:

    1. Lemke, Wolfgang & Vladu, Andreea L., 2016. "Below the zero lower bound: A shadow-rate term structure model for the euro area," Discussion Papers 32/2016, Deutsche Bundesbank.
    2. Beck, Guenter W. & Wieland, Volker, 2017. "How to normalize monetary policy in the Euro area," IMFS Working Paper Series 115, Goethe University Frankfurt, Institute for Monetary and Financial Stability (IMFS).
    3. Levieuge, Grégory & Sahuc, Jean-Guillaume, 2021. "Downward interest rate rigidity," European Economic Review, Elsevier, vol. 137(C).
    4. Ruchir Agarwal & Miles Kimball, 2019. "Enabling Deep Negative Rates to Fight Recessions: A Guide," IMF Working Papers 2019/084, International Monetary Fund.
    5. Christian Grisse & Signe Krogstrup & Silvio Schumacher, 2017. "Lower-Bound Beliefs and Long-Term Interest Rates," International Journal of Central Banking, International Journal of Central Banking, vol. 13(3), pages 165-202, September.
    6. Schupp, Fabian, 2020. "The (ir)relevance of the nominal lower bound for real yield curve analysis," Working Paper Series 2476, European Central Bank.
    7. Laine, Olli-Matti, 2020. "Monetary policy and stock market valuation," Research Discussion Papers 16/2020, Bank of Finland.
    8. Etienne Vaccaro-Grange, 2019. "Quantitative Easing and the Term Premium as a Monetary Policy Instrument," AMSE Working Papers 1932, Aix-Marseille School of Economics, France.
    9. Barbara Rossi, 2018. "Identifying and estimating the effects of unconventional monetary policy in the data: How to do It and what have we learned?," Economics Working Papers 1641, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 2020.
    10. Garcia Revelo, José David & Lucotte, Yannick & Pradines-Jobet, Florian, 2020. "Macroprudential and monetary policies: The need to dance the Tango in harmony," Journal of International Money and Finance, Elsevier, vol. 108(C).
    11. De Rezende, Rafael B. & Ristiniemi, Annukka, 2018. "A shadow rate without a lower bound constraint," Working Paper Series 355, Sveriges Riksbank (Central Bank of Sweden).
    12. Granziera, Eleonora & Sihvonen, Markus, 2020. "Bonds, Currencies and Expectational Errors," Research Discussion Papers 7/2020, Bank of Finland.
    13. Paloviita, Maritta & Haavio, Markus & Jalasjoki, Pirkka & Kilponen, Juha, 2017. "What does “below, but close to, two percent” mean? Assessing the ECB’s reaction function with real time data," Research Discussion Papers 29/2017, Bank of Finland.
    14. Coroneo, Laura & Pastorello, Sergio, 2020. "European spreads at the interest rate lower bound," Journal of Economic Dynamics and Control, Elsevier, vol. 119(C).
    15. Peter Tillmann, 2019. "Robust Monetary Policy Under Uncertainty About the Lower Bound," MAGKS Papers on Economics 201914, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    16. Geiger, Felix & Schupp, Fabian, 2018. "With a little help from my friends: Survey-based derivation of euro area short rate expectations at the effective lower bound," Discussion Papers 27/2018, Deutsche Bundesbank.
    17. Sarah Mouabbi & Jean‐Guillaume Sahuc, 2019. "Evaluating the Macroeconomic Effects of the ECB's Unconventional Monetary Policies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 51(4), pages 831-858, June.
    18. Holm-Hadulla, Fédéric & Thürwächter, Claire, 2021. "Heterogeneity in corporate debt structures and the transmission of monetary policy," European Economic Review, Elsevier, vol. 136(C).
    19. Schmöller, Michaela & Spitzer, Martin, 2020. "Endogenous TFP, business cycle persistence and the productivity slowdown in the euro area," Working Paper Series 2401, European Central Bank.
    20. Tillmann Peter, 2021. "Robust Monetary Policy Under Uncertainty About the Lower Bound," The B.E. Journal of Macroeconomics, De Gruyter, vol. 21(1), pages 309-321, January.
    21. Hartmann, Philipp & Smets, Frank, 2018. "The first twenty years of the European Central Bank: monetary policy," Working Paper Series 2219, European Central Bank.
    22. Rossi, Barbara, 2019. "Identifying and Estimating the Effects of Unconventional Monetary Policy: How to Do It And What Have We Learned?," CEPR Discussion Papers 14064, C.E.P.R. Discussion Papers.
    23. Claus, Edda & Claus, Iris & Krippner, Leo, 2018. "Asset market responses to conventional and unconventional monetary policy shocks in the United States," Journal of Banking & Finance, Elsevier, vol. 97(C), pages 270-282.

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    More about this item

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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