Lower bound uncertainty and long-term interest rates

Dr. Christian Grisse

Issue
2020-14

Pages
23

JEL classification
E43, E52

Keywords
Monetary policy, negative interest rates, lower bound, uncertainty, term structure

Year
2020

Nominal interest rates are constrained by an effective lower bound, but the level of the lower bound is uncertain. This paper uses a simple shadow rate term structure model to study how lower bound uncertainty affects long-term interest rates. The main result is that a decline in lower bound uncertainty, in the sense of a mean-preserving contraction of the lower bound distribution, is associated with a drop in expected future short rates. The effect on the variance of future short rates, and hence the term premium, is ambiguous. A calibration to Canadian data suggests that a decline in lower bound uncertainty is associated with a modest drop in long-term interest rates.