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Shadow short rate and monetary policy in the Euro area


Empirical modelling of the monetary policy effects using conventional linear econometric models is put to a great test when interest rates approach the zero-lower bound. A possible remedy recently proposed in the literature is to introduce a shadow short rate (SSR) obtained from the yield curve model as an alternative monetary policy measure. This paper examines the usefulness of shadow rates as a policy stance measure for the Euro area. Moreover, the SSR can be used to study the country-specific monetary policy stance. We incorporate the shadow short rate in a standard vector autoregressive analysis to study the effects of monetary policy shocks both at the level of the Euro area and for two periphery EA countries, Italy and Spain, that endured significant financial stress during the crisis. Our analysis shows that monetary policy shocks identified form the SSR produce similar macro responses as shocks identified from the standard policy rate. The Euro area shocks can directly translate to a corresponding change in the country-specific financing conditions in the periphery, whereas the reverse effect is limited. The historical decomposition of the stochastic component of the SSR series shows that the unconventional policy measures were effective in stabilising the sovereign crisis in 2011, however, their relatively limited quantity provided only a weak stimulus to the economy.

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  1. We are grateful to Leo Krippner for providing us the estimates.

  2. Other periphery countries are not included in the analysis due to data limitations.

  3. The data are seasonally adjusted. The Euro area data refers to EA12 aggregate.

  4. In principal, a similar analysis could be conducted also for core Euro area countries. Note, however, that this would be possible only to the extent the EA SSR and country-specific SSR exhibited were stochastically independent. As evident from Fig. 1 the EA SSR and Germany’s or France’s SSR co-move very closely and thus cannot be treated as fully independent. In fact, we verified that estimated VARs for Germany and France incorporating both the EA SSR and the country-specific SSR resulted in a singular covariance matrix of VAR innovations. In such a case, independent shocks to the EA SSR (common monetary policy shocks) and country-specific SSR cannot be identified. From the point of view of our modeling framework the policy stance of the EA core is most directly determined by the ECB and reflected in the EA SSR.

  5. We checked for robustness of our results by considering sign-restrictions as an alternative identification approach. The impulse response analysis remains qualitatively largely unaltered, which confirms the sensibility of our benchmark identification approach. Results are available upon request.

  6. The results for the Euro area historical decomposition are from the Euro area VAR we used to produce the impulse response analysis in Fig. 2.


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We would like to thank Leo Krippner for providing the shadow short rate estimates, and the participants of the NoEG meeting 2015 for providing valuable comments.

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Correspondence to Milan Damjanović.

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The views expressed in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Bank of Slovenia.


Appendix 1: VAR results and residual analysis

The VAR order was selected based on the most frequently suggested lag order by the 4 different information criteria starting from a maximum lag length of 10 quarters and corrected the lag length if necessary in case the model exhibited residual autocorrelation. If necessary we added dummy variables to address potential outliers in distributions of residuals. Based on repeated residual analysis, a model offering a better statistical specification was selected for the purpose of impulse response analysis. Final model contained 2 lags for Italy, whereas lag orders 3 and 4 were used for the Euro area and Spain respectively (Table 1).

Table 1 Specification tests of estimated VAR models

Appendix 2: Impulse responses to Euro area and country-specific shadow rate shocks

See Figs. 6, 7 and 8.

Fig. 6
figure 6

Impulse responses of output and prices to a monetary policy shock in Italy and Spain. a Italy. b Spain

Fig. 7
figure 7

Impulse responses to Euro area and country-specific shadow rate shocks—Italy. a Euro area SSR shock. b Italian SSR shock

Fig. 8
figure 8

Impulse responses to Euro area and country-specific shadow rate shocks—Spain. a Euro area SSR shock. b Spanish SSR shock

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Damjanović, M., Masten, I. Shadow short rate and monetary policy in the Euro area. Empirica 43, 279–298 (2016).

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  • Zero lower bound
  • Shadow short rate
  • Term structure
  • European central bank
  • VAR analysis
  • Historical decomposition

JEL Classification

  • E51
  • E32
  • E43
  • E44
  • E52
  • E58