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Estimating Shadow Policy Rates in a Small Open Economy and the Role of Foreign Factors

Jorge Fornero, Markus Kirchner and Carlos Molina ()

Working Papers Central Bank of Chile from Central Bank of Chile

Abstract: Shadow monetary policy rates (SMPRs) are useful to evaluate the policy 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 dynamic factor model, which allows to consider the impact of foreign monetary conditions on domestic ones. An application to Chile shows that under large negative shocks, unconventional policies drove the domestic SMPR to negative levels. Also, the SMPR is mainly driven by domestic (foreign) factors in the short (long) run, lending support to the classic trilemma.

Date: 2021-05
New Economics Papers: this item is included in nep-cba
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