A time series model of interest rates with the effective lower bound

Modeling nominal interest rates requires their effective lower bound (ELB) to be taken into account. We propose a flexible time series approach that includes a "shadow rate" - a notional rate identical to the actual nominal rate except when the ELB binds. We apply this approach to a trend-cycle decomposition of interest rates and macroeconomic variables that generates competitive interest-rate forecasts. Our estimates of the real-rate trend have edged down somewhat in recent decades, but not significantly so. We identify monetary policy shocks from shadow-rate surprises and find that they were particularly effective at stimulating economic activity during the ELB period.