A Shadow Policy Rate to Calibrate U.S. Monetary Policy at the Zero Lower Bound

Abstract

The recent global financial crisis, the Great Recession and the subsequent implementation of a variety of unconventional policy measures have raised the issue of how to correctly measure the stance of monetary policy when policy interest rates reach the zero lower bound (ZLB). In this paper, we propose a new "shadow policy rate" for the US economy, using a large set of data representing the various facets of the US Federal Reserve's policy stance. Changes in term premia at various maturities and asset purchases by the Fed are key drivers of this shadow rate. We document that our shadow policy rate tracks the effective federal funds rate very closely before the recent crisis. More importantly, it provides a reasonable gauge of US monetary policy stance when the ZLB becomes binding. This facilitates the assessment of the policy stance against familiar Taylor rule benchmarks. Finally, we show that in structural vector autoregressive (VAR) models, the shadow policy rate helps identify monetary policy shocks that better reflect the Federal Reserve's unconventional policy measures.