The Empirical Relevance of the Shadow Rate and the Zero Lower Bound

Abstract

This paper tests the statistical and economic differences in monetary policy implications using the shadow rate proposed in Wu and Xia (2016). Time-varying coefficient VAR models are fitted to US data from 1966–2017 that reveal stark economic and statistical differences in the structural implications of monetary policy that arise when replacing conventional interest rates with their shadow rate counterparts. Results prove strong support for utilising shadow rates within models of monetary policy under a binding zero lower bound constraint.

Keywords: Monetary Policy, Shadow Rate, Taylor Rules, Zero Lower Bound

JEL Classification: E32, E47, E51, E52, E58