Measuring the Stance of Monetary Policy on and off the Zero Lower Bound

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In December 2008, the Federal Open Market Committee (FOMC) lowered its target range for the federal funds rate to 0–25 basis points, effectively hitting the zero lower bound. The economy recovered slowly from the depth of the recession, and the FOMC did not lift the federal funds rate target from its lower bound until December 2015. The prolonged period at the zero lower bound raises the question of how to measure the overall stance of monetary policy when constraints prevent the FOMC from using its traditional policy tool—the target federal funds rate. Doh and Choi propose a new “shadow short-term interest rate” that reflects both government and private-sector borrowing conditions. Their measure of the new shadow rate closely tracks the effective federal funds rate during the period before the zero lower bound. Furthermore, they find inflation and unemployment respond to the shadow rate much as they did to the effective federal funds rate before the zero lower bound period.

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