Assessing the Effective Stance of Monetary Policy: A Factor-Based Approach

We present an empirical approach to derive the implicit stance of monetary policy. The indicator can be interpreted as an implied short-term interest rate that is not restricted by the effective lower bound. Factor analysis is used to extract an expectations and term premium component from fitted yield curve data. Based on this, an implied short-term interest rate is constructed, which reflects how much the short-term rate should have fallen to achieve observed drop in long-term yields, assuming it could not have been caused by a fall in the term premium. Following Lombardi and Zhu (2014), we study how the implied rate performs as instrument for monetary policy analysis. Regression analyses suggests that the implied rate provides a good gauge for the identification of non-standard monetary policy shocks, and has responded significantly to financial stress as opposed to the output and inflation gap.