We propose a shadow rate without a lower bound constraint that measures the overall stance of monetary policy in any policy environment, prior and during the lower-bound period, as well as in the current “New Normal” environment, where unconventional monetary policies have become more standard. Using daily yield curve data we estimate shadow rates for the US, Sweden, the euro area and the UK, and document that they fall (rise) as monetary policy becomes more expansionary (contractionary), following announcements of policy rate cuts (hikes), forward guidance, and balance sheet expansions (contractions). In addition, we show two applications for our shadow rate. First, we decompose shadow rate responses to monetary policy announcements into conventional and unconventional monetary policy surprises, and assess the pass-through of each type of policy to exchange rates. We find that exchange rates respond more to conventional than to unconventional monetary policy. Lastly, counterfactual experiments in two DSGE models suggest that inflation in the US and in Sweden would have been on average about 0.8 and 0.33 percentage points lower, respectively, had unconventional monetary policy not been used.

Financial markets have been shaken by the surge of a banking crisis in early 2023. The failure of Silicon Valley Bank has raised concerns about the health of various financial institutions in a period of rapid monetary contraction and high interest rates. I discuss the stress levels of sixty US regional banks, by proposing a new “bank stress indicator”, based on an event study framework. The indicator suggests six highly stressed banks: First Republic Bank, Western Alliance Bancorporation, KeyCorp, Comerica Incorporated, Zions Bancorporation and PacWest Bancorp. Although most of these banks have been highly profitable and have built solid balance sheet positions over the past years, they have faced large shares of uninsured deposits, which have put them at risk. The new Bank Term Funding Program launched by the Fed is designed to help in this matter, lowering the risk of new failures.

Inflation in the US and other economies continues to climb. I discuss reasons why a monetary contraction willnot be enough to bring inflation back to target levels without causing a recession, and that a fiscal adjustmentmay be necessary as additional measure. The main obstacle for monetary policy to contain the gallop of pricesis the resulting highly negative real interest rates and the high debt levels observed, which make the call for afiscal adjustment. Otherwise, an even higher inflationary spiral may occur, as debtors may wish to takeadvantage of the highly negative real interest rates and engage in even more debt and spending. One of thosedebtors is the government, which constant deficits and increasing debt may trigger a loss of faith in thecurrency, keeping inflation on the rise. A fiscal adjustment is pertinent. I also discuss policy scenarios andimplications for investments. 

We propose a shadow rate that measures the overall stance of monetary policy when the lower bound is not necessarily binding. Using daily yield curve data we estimate shadow rates for the US, Sweden, the euro area and the UK, and document that they fall (rise) as monetary policy becomes more expansionary (contractionary). This ability of the shadow rate to track the stance of monetary policy is identified on announcements of policy rate cuts (hikes), balance sheet expansions (contractions) and forward guidance, with shadow rates responding in a timely fashion, and in line with government bond yields. We show two applications for our shadow rate. First, we decompose shadow rate responses to monetary policy announcements into conventional and unconventional monetary policy surprises, and assess the pass-through of each type of policy to exchange rates. We find that exchange rates respond more to conventional than to unconventional monetary policy. Lastly, a counterfactual experiment in a DSGE model suggests that inflation in Sweden would have been around half a percentage point lower had unconventional monetary policy not been used since February 2015.

We propose a shadow rate that measures the expansionary (contractionary) interest rate effects of unconventional monetary policies that are present when the lower bound is not binding. Using daily yield curve data we estimate shadow rates for the US, Sweden, the euro-area and the UK, and find that they fall (rise) when market participants expect monetary policy to become more expansionary (contractionary), and price this information into the yield curve. This ability of the shadow rate to track the stance of monetary policy is identified on announcements of policy rate cuts (hikes), balance sheet expansions (contractions) and forward guidance, with shadow rates responding timely, and in line with government bond yields. We show two applications for our shadow rate. First, we decompose shadow rate responses to monetary policy announcements into conventional and unconventional monetary policy surprises, and assess the pass-through of each type of policy to exchange rates. We find that exchange rates respond more to conventional than to unconventional monetary policy. Lastly, a counterfactual experiment in a DSGE model suggests that inflation in Sweden would have been around 0.47 percentage points lower had the Riksbank not used unconventional monetary policy since February 2015. 

This article provides an overview of recent developments in term structure modeling and its uses by central banks. The topic is important to central banks and policymakers, who are often interested in extracting economic information from long-term interest rates, and elaborating policies to influence them. I review some of the term structure models that allow for time-varying risk premia and that have served as the workhorse models in the analysis of the term structure of interest rates by central banks. These models have been used to measure policy rate expectations, to study the interest rate transmission mechanisms of unconventional monetary policies, to estimate inflation and liquidity risk premia in real government bond markets and to obtain useful policy indicators in an interest rate lower bound environment, such as the shadow rate.

I analyze the recent experience of unconventional monetary policy in Sweden to study the interest rate transmission mechanisms of government bond purchases when interest rates are away from the lower bound. Using dynamic term structure models and event study regressions I find that government bond purchases have important portfolio balance and signaling effects. The signaling channel operates mainly by lowering short-rate expectations in the intermediate segment of the yield curve, while the portfolio balance channel is effective in lowering longer maturity term premia. In addition, I find that target interest rate policy and government bond purchases operate in different segments of the yield curve. This suggests that a combination of the two policies can be used to lower interest rates across the whole maturity spectrum, making monetary policy more expansionary. 

I analyze the recent experience of unconventional monetary policy in Sweden to study the interest rate transmission mechanisms of government bond purchases when interest rates are away from the lower bound. Using dynamic term structure models and event study regressions I find that government bond purchases have important portfolio balance and signaling effects. The signaling channel operates mainly by lowering short-rate expectations in the intermediate segment of the yield curve, while the portfolio balance channel is effective in lowering longer maturity term premia. In addition, I find that target interest rate policy and government bond purchases operate in different segments of the yield curve. This suggests that a combination of the two policies can be used to lower interest rates across the whole maturity spectrum, making monetary policy more expansionary. 

The Riksbank purchase government bonds with the aim of making monetary policy more expansionary and supporting a development whereby inflation returns to the target of 2 per cent. Our analysis shows to what extent the purchases have had an effect on interest rates, exchange rates and asset prices. Our assessment is that the purchases have contributed to making Swedish interest rates lower than they otherwise would have been. This has contributed to reducing the interest rate differential in relation to other countries and led to the krona being at a weaker level than it otherwise would have been. Seen in relation to the value of the bonds the Riksbank has purchased, the effects are in line with those observed in other countries. 

I provide evidence that risks in macroeconomic fundamentals contain valuable information about bond risk premia. I extract factors from a set of quantile-based risk measures estimated for US macroeconomic variables and document that they account for up to 31% of the variation in excess bond returns. The main predictor factors are associated with point expectations of real economic activity, uncertainty about real GDP growth, and downside and upside risks in housing starts and the unemployment rate. In addition, factors provide information about bond risk premia variation that is largely unrelated to that contained in the Cochrane-Piazzesi and Ludvigson-Ng factors. These results are confirmed statistically and economically in an out-of-sample setting and hold when factors are constructed using macroeconomic data available in real-time. All together, these findings suggest that risks to macroeconomic fundamentals are an important source of fluctuations in the US government bond market.