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Taylor Rule and Shadow Rates: theory and empirical analysis

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  • Camilla Lupiani

Abstract

In view of the persistent zero lower bound, which has dominated the European financial landscape since December 2012, the European Central Bank (ECB) has implemented unconventional monetary policies. However, the effects of these unconventional policies have not been fully captured by the traditional reference rates, which have remained anchored at values close to or below the zero lower bound. In order to assess the impact of these measures in more detail, the concept of "shadow rates" was introduced. These shadow rates, often based on financial indicators, provide a more comprehensive view of the overall macroeconomic situation. The present study aims to compare the predictive accuracy of a Taylor rule based on shadow rates with that based on the reference rate, the €str, in an out-of-sample period. The results of this analysis highlight that a Taylor rule based on shadow rates offers a more accurate representation of the stance of the monetary policy, and is even used by monetary analysts to form expectations, especially when the central bank does not provide clear guidance. This study suggests that incorporating the shadow rate into the Taylor rule could provide valuable insights for guiding monetary policy and get a deeper understanding of the macroeconomic landscape.

Suggested Citation

  • Camilla Lupiani, 2024. "Taylor Rule and Shadow Rates: theory and empirical analysis," BAFFI CAREFIN Working Papers 24218, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    • Handle: RePEc:baf:cbafwp:cbafwp24218
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    More about this item

    Keywords

    central bank; ECB; interest rate; shadow rate; GMM; efficiency; zero lower bound; effective lower bound;
    All these keywords.

    JEL classification:

    • E02 - Macroeconomics and Monetary Economics - - General - - - Institutions and the Macroeconomy
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F01 - International Economics - - General - - - Global Outlook

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