Measuring Monetary Policy when the Nominal Short-Term Interest Rate is Zero: A Dynamic Stochastic Genearl Equilibrium Approach

This paper proposes an empirical dynamic stochastic general equilibrium (DSGE) framework to measure monetary policy when the nominal short-term interest rate is zero. The framework assumes that there exists a shadow rate which represents the monetary policy stance of a central bank. When the shadow rate is positive, it is observed as the policy rate of the central bank. However, when it is negative, it deviates from the policy rate which remains at its lower-bound of zero. It is not the policy rate but the shadow rate that affects the economy when the two rates deviate. With this framework, standard DSGE models can be fitted to data using a version of particle filter, and the historical movements of the shadow rate can be estimated. As an application, we estimate a small New Keynesian model using Japanese data. The results suggest that the shadow rate was well below zero during the period of zero policy rate in the 2000s.