Shadow Short Rate Research Articles

Dynamic Spillovers from US (Un)Conventional Monetary Policy to African Equity Markets: A Time-Varying Parameter Frequency Connectedness and Wavelet Coherence Analysis

Since the implementation of unconventional monetary policies (UMPs) by the US in response to the global financial crisis (GFC) and the COVID-19 pandemic, there have been increasing concerns that these forward guidance and quantitative easing programmes have had spillover effects on global equity markets. We specifically question whether the implementation of these UMPs have had spillovers to African equities, which have been previously speculated to be decoupled from global markets and shocks. Time-varying-parameter (TVP) frequency connectedness and wavelet coherency methods were used to examine the dynamic time-frequency spillovers between daily time series of the US shadow short rate and African equities returns/volatility between 1 January 2007 and 31 March 2023. On one hand, the TVP frequency connectedness analysis reveals robust long-run spillovers from US monetary policy to African equity markets during specific periods: 2009, 2013, 2020, and 2021. These coincide with instances when the Federal Reserve announced their transition from conventional to unconventional monetary practices and vice versa. On the other hand, the wavelet analysis provides insights into the ‘sign’ of the spillovers, indicating mixed phase dynamics during UMPs responding to the GFC. In contrast, anti-phase or negative co-movements characterize UMPs implemented during the COVID-19 pandemic, implying that these policies increased both returns and volatilities to African equities. Altogether, we conclude that US UMP has increasing deteriorated market efficiency and amplified portfolio risk in African equities whilst during ‘normalization’ periods US monetary policy has little transmission effect.

Monetary policy and uncertainty spillovers: Evidence from a wavelet and frequency connectedness analysis

Interconnected financial markets, especially those stemming from changes in monetary policy or shifts in financial, political, or geopolitical conditions, ease the transmission of spillovers. Understanding these dynamics is crucial for policymakers and investors. Therefore, identifying cross-country spillovers across time and frequency domains, along with assessing the role of monetary policy during periods of economic instability and escalating geopolitical risk, holds significant importance. This study contributes to the literature by revealing important aspects of network connectedness among monetary policy and uncertainty indices, in terms of frequency and time horizon, for the US and the UK, over the period 2014–2023. First, we find stronger interdependence between the series in the long term, with short-medium run connectedness prevailing during specific periods and events, such as Brexit, the COVID-19 pandemic, and the Russian-Ukrainian War. Second, shadow short rates often receive spillovers from financial stress in the short-medium term but transmit spillovers in the long term, implying the stabilizing influence of monetary policy in the long run. Third, geopolitical risk is responsible for most of the spillovers reflected in financial and economic uncertainty in 2022, and finally, the US emerges as the dominant transmitter of spillovers to the UK.

Monetary policy uncertainty and ESG performance across energy firms

This study investigates the relationship between monetary policy uncertainty and the Environmental, Social, and Governance (ESG) performance of energy firms. For empirical analysis this study used unbalanced panel data of 3991 firm-year observations from 35 countries covering the period from 2002 to 2021. Utilizing the Shadow Short Rate as a proxy for monetary policy uncertainty, our baseline results reveal a consistent negative association between uncertainty and ESG performance within the energy sector. To address endogeneity concerns, two-step system GMM, 2SLS, and PSM were employed. The channel analysis on the interaction between monetary policy uncertainty and eco-friendly practices indicated a positive association between the interaction and energy firms' ESG performance. Thus, strategic alignment with sustainability goals is crucial for mitigating the adverse impacts of monetary policy uncertainty and ensuring long-term ESG performance of energy firms. Policy implications suggest that regulators can contribute to economic stability by reducing uncertainty, while policymakers can incentivize sustainable practices.

International financial stress spillovers during times of unconventional monetary policy interventions

In this study, we estimate a Bayesian global vector autoregressive model to uncover the effects of financial stress on output growth, inflation, and interest rates, accounting for several advanced and emerging economies for a period spanning from February 2008 until May 2022. We construct a financial stress index applicable to all countries, tracking periods of financial instability in the economies, and employ shadow short rates as a proxy measure of unconventional monetary policy. This study provides strong evidence that financial stress shocks are transmitted abroad as financial stress increases in all the countries in the sample. Our results also show that financial stress innovation generates important domestic and cross-border output, inflation, and interest rate spillovers for several countries. Additionally, we identify the active role of the financial and bank credit channels in the transmission of shocks across financial systems, while macroprudential policy can intercept the propagation of the shock. Our results carry policy implications for monetary and regulatory authorities.

Global liquidity spillovers in the Asia–Pacific region: policy-driven versus market-driven effects

This research investigates the spillovers of global liquidity to Asia–Pacific countries, focusing on the contradictory effects of policy-driven liquidity created by monetary stances in advanced economies and market-driven liquidity generated by the private banking sector. Our findings stand in sharp contrast to previous studies, showing that shifts in macro-financial indicators in Asia–Pacific economies are predominantly influenced by market-driven shocks rather than those of policy-driven liquidity. Specifically, liquidity shocks associated with surges in cross-border credit flows, especially those denominated in US dollars, drive up asset prices and have boosting effects on inflation and economic output. A positive shock to market liquidity also results in an appreciation pressure on domestic currencies and a short-term rise in interest rates. However, excess liquidity shocks caused by the Bank of Japan’s adjustments in shadow short rates and balance sheets have a negative effect on inflation and bring about temporary depreciation pressure on Asian currencies. Surprisingly, we find that Asian responses to financial easing associated with the Fed’s monetary policy change are not well-pronounced.

Monetary policy and currency variance risk premia

I analyze how the stance of monetary policy predicts variance risk premia in the currency market. The stance of monetary policy is measured using the shadow short rate, and two year and ten year bond yields. The stance of U.S. monetary policy predicts currency variance risk premia, after controlling for the stance of the foreign currency’s monetary policy. Contractionary U.S. monetary policy predicts lower currency variance risk premia, consistent with an increase in investor risk aversion. In contrast, the stance of the foreign currency’s monetary policy does not predict currency variance risk premia, after controlling for the stance of U.S. monetary policy.

Time-varying relationship between international monetary policy and energy markets

This paper examines the spillover dynamics and connectedness between international monetary policies of four developed economies (i.e., UK, US, Japan and Eurozone) and energy markets (i.e., crude oil, heating oil, gasoline and propane) while accounting for the impact of global volatility, economic uncertainty and geopolitical risk factors. This paper uses the time-varying parameter vector auto-regression (TVP-VAR) and TVP-VAR-based extended joint connectedness models to explore the connectedness of monetary policy and energy markets using daily data from June 1, 2007, to March 31, 2022. The results reveal a time-varying connectedness between the energy markets and international monetary policy, and global events affect the magnitude of connectedness. In all, energy markets were found to be the major shock transmitters and monetary policy the receiver. Additionally, we found that energy dependence explains why the Euro Area shadow short rate is more related to energy markets than other monetary policies. The findings also show “Oil to monetary policy” risk spillover, which suggests oil price controls monetary policy. Finally, economic uncertainty positively affects monetary policy and energy price connectedness.

Interplay of multifractal dynamics between shadow policy rates and energy markets

This study examines the interconnections between short shadow rates (SSR) and energy markets. We conduct multifractal detrended cross-correlation analysis (MF-DXA) on the daily SSR from four major economies (USA, Eurozone, Japan, and UK) and the daily prices of four energy markets (WTI, Brent, Natural Gas, and Heating Oil) spanning January 1995 to March 2022. Our analysis shows that all energy market-short shadow rate pairs display significant multifractal characteristics. The presence of power law cross-correlation suggests that substantial changes in short shadow rates are associated with significant price changes in energy markets. The highest multifractal cross-correlation is observed between energy prices and shadow short rates of Japan and the US. Energy markets demonstrate persistent cross-correlations for small fluctuations compared to large fluctuations. However, the rolling windows analysis reveal a shift from persistent to anti-persistence cross-correlations during global financial crises (GFC), the 2014–2016 energy crises and the COVID-19 pandemic. Lastly, the cross-correlation exhibit positive skewness. We suggest that integrating these long-term dependency features into financial analysis has the potential to support decision-making for market participants.

Interplay of multifractal dynamics between shadow policy rates and stock markets

Stock markets are generally perceived as a barometer of the economy and respond to international monetary policies even before economic activities. Many central banks have turned to unconventional policy measures in response to various financial crises such as the global financial crisis of 2007–2009 or the recent crisis caused by COVID-19. To examine the cross-correlation of overall international monetary policies with stock markets, we employ the daily shadow short rate (SSR), which has the advantage of allowing comparison across unconventional and conventional regimes. The analysis is made through a multifractal context using multifractal detrended cross correlation analysis (MF-DXA), considering daily data from 1st January 2000 to 31st March 2022 and country specific SSR and the stock markets of eight developed economies. The main empirical findings are the following: (i) all the country specific pairs of SSR with stock markets have significant multifractal characteristics (ii) the pairs of NZ-SSR/NZX50, US-SSR/DJIA, and CN-SSR/S&P TSX have the highest multifractal patterns while EU-SSR/Euro-area Index has the lowest multifractal patterns (iii) Australian and New Zealand stock markets exhibit anti-persistent cross-correlation with SSR while the remainder have persistent cross-correlation in their multifractality. Lastly, the findings of this study have several important implications for central banks and stock market participants.

The COVID-19 pandemic, policy responses and stock markets in the G20

This paper analyses the impact of the Covid-19 pandemic on stock market returns and their volatility in the case of the G20 countries. In contrast to the existing empirical literature, which typically focuses only on either Covid-19 deaths or lockdown policies, our analysis is based on a comprehensive dynamic panel model accounting for the effects of both the epidemiological situation and restrictive measures as well as of fiscal and monetary responses; moreover, instead of Covid-19 deaths it uses a far more sophisticated Covid-19 index based on a Balanced Worth (BW) methodology, and it also takes into account heterogeneity by providing additional estimates for the G7 and the remaining countries (non-G7) separately. We find that the stock markets of the G7 are affected negatively by government restrictions more than the Covid-19 pandemic itself. By contrast, in the non-G7 countries both variables have a negative impact. Further, lockdowns during periods with particularly severe Covid-19 conditions decrease returns in the non-G7 countries whilst increase volatility in the G7 ones. Fiscal and monetary policy (the latter measured by the shadow short rate) have positive and negative effects, respectively, on the stock markets of the G7 countries but not of non-G7 ones. In brief, our evidence suggests that restrictions and other policy measures play a more important role in the G7 countries whilst the Covid-19 pandemic itself is a key determinant in the case the non-G7 stock markets.

Influence of unconventional monetary policy on agricultural commodities futures: network connectedness and dynamic spillovers of returns and volatility

ABSTRACT Our research examines connectedness landscape and the dynamic spillovers of volatility and returns in the network comprising eleven agricultural commodities and US shadow short rate in a quality of inflation indicator, observed in monetary policymaking. We use daily data from November 2000 to May 2021. We document monetary policy as a net transmitter of spillover for both return and volatility of agricultural commodities. We find significant volatility connectedness among agricultural commodities. The connectedness is shown to be of a time-varying nature, exhibiting considerable increases during periods of market turmoil. The results of this paper provide relevant insights into the interrelations of US monetary policy and agricultural commodity prices, being, hence, potentially useful for commodity investors, brokers and dealers, as well as for market regulators designing policy solutions for financial stability enhancements.

The COVID-19 Pandemic, Policy Responses and Stock Markets in the G20

This paper analyses the impact of the Covid-19 pandemic on stock market returns and their volatility in the case of the G20 countries. In contrast to the existing empirical literature, which typically focuses only on either Covid-19 deaths or lockdown policies, our analysis is based on a comprehensive dynamic panel model accounting for the effects of both the epidemiological situation and restrictive measures as well as of fiscal and monetary responses; moreover, instead of Covid-19 deaths it uses a far more sophisticated Covid-19 index based on a Balanced Worth (BW) methodology, and it also takes into account heterogeneity by providing additional estimates for the G7 and the remaining countries (non-G7) separately. We find that the stock markets of the G7 are affected negatively by government restrictions more than the Covid-19 pandemic itself. By contrast, in the non-G7 countries both variables have a negative impact. Further, lockdowns during periods with particularly severe Covid-19 conditions decrease returns in the non-G7 countries whilst increase volatility in the G7 ones. Fiscal and monetary policy (the latter measured by the shadow short rate) have positive and negative effects, respectively, on the stock markets of the G7 countries but not of non-G7 ones. In brief, our evidence suggests that restrictions and other policy measures play a more important role in the G7 countries whilst the Covid-19 pandemic itself is a key determinant in the case the non-G7 stock markets.

Conventional and unconventional monetary policy reaction to uncertainty in advanced economies: evidence from quantile regressions

Abstract This paper investigates how the Federal Reserve (Fed) and the Bank of England, Bank of Japan and the European Central Bank reacted in the aftermath of the financial crisis by making use of both conditional and unconditional interest rate quantiles regressions and data on shadow short rate of interest and a measure of uncertainty. Firstly, the unconditional quantile regression offers some support for increased reaction by the Fed as the ZLB is approached. Secondly, the decreased reaction of the Fed and other monetary policy makers towards uncertainty particularly at lower conditional quantiles of interest rates lends support to expansionary mechanism in place during this time. Hence uncertainty is key to policy reaction, and more so during episodes of crisis.

Unconventional monetary policy reaction functions: evidence from the US

Abstract We specify unconventional monetary policy reaction functions for the Fed using linear and nonlinear econometric frameworks. We find that nonstandard policy measures are largely driven by the dynamics of inflation and the output gap, with the effect being particularly strong during QE rounds. Moreover, we uncover the presence of asymmetry and regime dependence in central bank’s actions since the global financial crisis, especially concerning the response of the term spread and the shadow short rate to the growth rate of central bank reserves. From a policy perspective and given the lack of a systematic response of monetary policy to asset price growth in nonstandard times, our findings seem to corroborate the view that concerns about asset price bubbles, financial sector pro-cyclicality and systemic risk should be part of the macro-prudential policy toolkit.

International monetary policy spillovers: Evidence from a time-varying parameter vector autoregression

This study examines the transmission of international monetary policy spillovers across developed economies based on a Bayesian time-varying parameter vector autoregressive (TVP-VAR) connectedness methodology. The analysis is based on daily shadow short rates over the period of January 2, 1995 to December 20, 2018. The empirical findings suggest that the magnitude of international monetary policy spillovers behaves heterogeneously over time, with unprecedented heights reached during the Great Recession of 2009, suggesting potential gains from unconventional monetary policy coordination. In addition, the results indicate that the dominant transmitters of international monetary policy spillovers are the Euro Area and the US, while Japan and the UK are the dominant receivers of spillovers. Our results are robust to alternative experimentations in terms of estimation and prior choices used to estimate the TVP-VAR.

Volatility Spillovers between Interest Rates and Equity Markets of Developed Economies

Abstract This study employs the recently developed Lagrange multiplier-based causality-in-variance test by Hafner and Herwartz (2006), to determine the volatility spillovers between interest rates and stock returns for the US, the euro area, the UK, and Japan. The investigation pays careful attention to volatility transmissions between stock returns and interest rates before and after these economies reached the Zero Lower Bound (ZLB), which is permitted via the use of Shadow Short Rates (SSR), used as a proxy for monetary policy decisions. The results based on daily data imply that while bidirectional causality is observed, the volatility spillover from interest rates to stock markets are more prominent for the full-sample, as well as the sub-samples covering the pre- and during-ZLB periods.

Asset market responses to conventional and unconventional monetary policy shocks in the United States

Abstract We quantify the responses of a wide range of United States financial market variables to domestic monetary policy shocks over conventional and unconventional monetary policy environments. Our results show that responses to policy shocks are in the same direction but generally larger and more significant in the unconventional period. The larger responses are mostly due to larger shocks in the unconventional period, but some variables show evidence of a larger transmission of shocks. We separately use our framework to test shadow short rate estimates as a proxy for short-maturity interest rates across conventional and unconventional periods.

A Comment on Wu and Xia (2016) from a Macroeconomic Perspective

Counter to the comments in Wu and Xia (2016), I show that the results from macroeconomic models are sensitive to the Shadow Short Rate (SSR) series used. That is, using a standard small macroeconomic vector autorregression model with a range of estimated SSR series obtains counterfactuals for unemployment ranging from 0.4 to 1.8 percentage points, if the Federal Funds Rate rather than the SSR series had been applied in the lower bound period. The counterfactuals for inflation range from -0.2 to -2.2 percentage points. Vetting the various SSR series from several perspectives indicates that some are more preferable than others, but there are reasons to remain cautious on the associated results.

Risk aversion, uncertainty, and monetary policy in zero lower bound environments

Bekaert et al. (2013) show that a lax monetary policy decreases both risk aversion and uncertainty, and that shocks to risk aversion and uncertainty induce changes in monetary policy. We extend their analysis for the pre-crisis period to the post-crisis period by using a “shadow short rate” as a proxy for unconventional monetary policies in zero lower bound environments. We find that the empirical link between monetary policy, risk aversion, and uncertainty found in Bekaert et al. (2013) persists even in the post-crisis period, but the link is uncovered only when the shadow short rates are used to measure the monetary policy stance.

Monetary Policy Spillovers across the Pacific when Interest Rates Are at the Zero Lower Bound

To conduct monetary policy effectively, central banks need to understand the transmission of monetary policy into financial markets. In this paper we investigate the effects of Japanese and U.S. monetary policy shocks on their own asset markets, and the spillovers into each other's markets. Because short-term nominal interest rates have been effectively zero in Japan since January 1998 and in the United States from late 2008, however, monetary policy shocks cannot be quantified by considering observable changes in short-term market interest rates. Therefore, in our analysis we use a shadow short rate―a quantitative measure of overall conventional and unconventional monetary policy that is estimated from the term structure of interest rates. Our results suggest that the operation of monetary policy at the zero lower bound of interest rates alters the transmission of shocks. In particular, we find a limited response of exchange rates during the first episode of unconventional monetary policy in Japan but a significant impact since 2006.