A shadow rate model with time-varying lower bound of interest rates

Tomi Kortela

No 19/2016, Bank of Finland Research Discussion Papers from Bank of Finland

Abstract: Typically a constant – or zero – lower bound for interest rates is applied in shadow rate term structure models. However, euro area yield curve data suggest that a time-varying lower bound might be appropriate for the euro area. I show that this indeed is the case, i.e. a shadow rate model with time-varying lower bound outperforms the constant lower bound model in euro area data. I argue that the time-variation in the lower bound is related to the deposit facility rate and, thus, to monetary policy. This time-variation in the lower bound gives a new channel via which monetary policy may affect the yield curve in a shadow rate model. I show that the intensity of this channel depends on how tightly the lower bound restricts the yield curve, and I argue that this channel has recently become important for the euro area.

JEL-codes: E43 E44 E52 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (12)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bofrdp:rdp2016_019

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