Estimating shadow policy rates in a small open economy and the role of foreign factors

Jorge Fornero, Markus Kirchner and Carlos Molina

Journal of International Money and Finance, 2024, vol. 140, issue C

Abstract: Shadow monetary policy rates (SMPRs) are useful to evaluate the monetary stance when interest rates are at their lower bounds and unconventional policies are implemented. We present a methodology to estimate an SMPR for the case of a small open economy based on a structural dynamic factor model, which allows to consider the impact of foreign monetary conditions on domestic ones and identify their respective role for the domestic monetary stance. An application to Chile shows that unconventional policies drove the estimated domestic SMPR to negative levels during crisis episodes, with an important role for foreign factors. Alternative specifications that neglect small open economy dimensions yield noisy and less robust results, and imply very different conclusions about the level and drivers of the estimated SMPR.

Keywords: Effective lower bound; Unconventional monetary policy; Shadow interest rate; Dynamic factor models; Small open economy (search for similar items in EconPapers)
JEL-codes: C38 E52 E58 F41 (search for similar items in EconPapers)
Date: 2024
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Working Paper: Estimating Shadow Policy Rates in a Small Open Economy and the Role of Foreign Factors (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:140:y:2024:i:c:s0261560623001730

DOI: 10.1016/j.jimonfin.2023.102972

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