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

45 Pages Posted: 20 Aug 2018 Last revised: 21 Feb 2019

See all articles by Martin M. Andreasen

Martin M. Andreasen

Aarhus University; CREATES, Aarhus University

Andrew Meldrum

Board of Governors of the Federal Reserve System

Date Written: 2018-08-13

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.

Keywords: Quadratic term structure models, Sequential regression approach, Shadow rate models, Zero lower bound

JEL Classification: E43, E47, G12

Suggested Citation

Andreasen, Martin M. and Meldrum, Andrew, A Shadow Rate or a Quadratic Policy Rule? The Best Way to Enforce the Zero Lower Bound in the United States (2018-08-13). FEDS Working Paper No. 2018-056, Available at SSRN: https://ssrn.com/abstract=3234194 or http://dx.doi.org/10.17016/FEDS.2018.056

Martin M. Andreasen (Contact Author)

Aarhus University ( email )

Aarhus
Denmark

CREATES, Aarhus University ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

HOME PAGE: http://econ.au.dk/research/research-centres/creates/people/junior-fellows/martin-andreasen/

Andrew Meldrum

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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