Taylor Rule and Shadow Rates: theory and empirical analysis

Camilla Lupiani

No 24218, BAFFI CAREFIN Working Papers from BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy

Abstract: In view of the persistent zero lower bound, which has dominated the European financial landscape since December 2012, the European Central Bank (ECB) has implemented unconventional monetary policies. However, the effects of these unconventional policies have not been fully captured by the traditional reference rates, which have remained anchored at values close to or below the zero lower bound. In order to assess the impact of these measures in more detail, the concept of "shadow rates" was introduced. These shadow rates, often based on financial indicators, provide a more comprehensive view of the overall macroeconomic situation. The present study aims to compare the predictive accuracy of a Taylor rule based on shadow rates with that based on the reference rate, the €str, in an out-of-sample period. The results of this analysis highlight that a Taylor rule based on shadow rates offers a more accurate representation of the stance of the monetary policy, and is even used by monetary analysts to form expectations, especially when the central bank does not provide clear guidance. This study suggests that incorporating the shadow rate into the Taylor rule could provide valuable insights for guiding monetary policy and get a deeper understanding of the macroeconomic landscape.

Keywords: central bank; ECB; interest rate; shadow rate; GMM; efficiency; zero lower bound; effective lower bound (search for similar items in EconPapers)
JEL-codes: E02 E43 E52 E58 F01 (search for similar items in EconPapers)
Pages: 66
Date: 2024
New Economics Papers: this item is included in nep-ban, nep-cba, nep-eec, nep-mac and nep-mon
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