Measuring Monetary Policy Under Zero Interest Rates With a Dynamic Stochastic General Equilibrium Model: An Application of a Particle Filter

This paper proposes an empirical dynamic stochastic general equilibrium (DSGE) framework to measure the degree of monetary policy accommodation when the nominal interest rate is zero. The framework employs a hypothetical DSGE model in which the nominal interest rate can be lowered below zero because, for instance, the central bank can impose a 'carry tax' on currency. We call the model's nominal interest rate the 'shadow rate.' When the shadow rate is positive, it is observed as the actual nominal interest rate set by the central bank. When it is negative, however, it deviates from the actual nominal interest rate which remains at its lower-bound of zero. In the model, it is not the actual nominal interest rate but the shadow rate that affects the economy when the two rates deviate. The hypothetical DSGE model can be fit to data using a version of particle filters, and the historical movements of the shadow rate can be estimated. As an application, we estimate a small New Keynesian model using Japanese data. The results suggest that the shadow rate was well below zero during the period when the nominal interest rate was zero in the early 2000s.