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A Shadow Rate or a Quadratic Policy Rule? The Best Way to Enforce the Zero Lower Bound in the United States

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Abstract

We study whether it is better to enforce the zero lower bound (ZLB) in models of U.S. Treasury yields using a shadow rate model or a quadratic term structure model. We show that the models achieve a similar in-sample fit and perform comparably in matching conditional expectations of future yields. However, when the recent ZLB period is included in the sample, the models ' ability to match conditional expectations away from the ZLB deteriorates because the time-series{{p}}dynamics of the pricing factors change. In addition, neither model provides a reasonable description of conditional volatilities when yields are away from the ZLB.

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  • Martin M. Andreasen & Andrew C. Meldrum, 2018. "A Shadow Rate or a Quadratic Policy Rule? The Best Way to Enforce the Zero Lower Bound in the United States," Finance and Economics Discussion Series 2018-056, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2018-56
    DOI: 10.17016/FEDS.2018.056
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    Cited by:

    1. Salman Huseynov, 2021. "Long and short memory in dynamic term structure models," CREATES Research Papers 2021-15, Department of Economics and Business Economics, Aarhus University.
    2. Peter Hördahl & Oreste Tristani, 2019. "Modelling yields at the lower bound through regime shifts," BIS Working Papers 813, Bank for International Settlements.
    3. Martin M. Andreasen & Kasper Joergensen & Andrew C. Meldrum, 2019. "Bond Risk Premiums at the Zero Lower Bound," Finance and Economics Discussion Series 2019-040, Board of Governors of the Federal Reserve System (U.S.).
    4. Jens H. E. Christensen & Jose A. Lopez & Paul Mussche, 2021. "International Evidence on Extending Sovereign Debt Maturities," Working Paper Series 2021-19, Federal Reserve Bank of San Francisco.
    5. Martin Møller Andreasen & Kasper Jørgensen & Andrew Meldrum, 2019. "Bond Risk Premiums at the Zero Lower Bound," CREATES Research Papers 2019-10, Department of Economics and Business Economics, Aarhus University.

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    More about this item

    Keywords

    Quadratic term structure models; Sequential regression approach; shadow rate models; Zero lower bound;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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