Time-Varying Lower Bound of Interest Rates in Europe∗

We study the effectiveness of the ECB’s negative interest rate policy on the yield curve with a new shadow-rate term structure model. Our model captures the discrete nature of the policy rate and a non-constant spread between it and the short end of the government bond yield curve. We price bonds with forward-looking agents, and find all modeling components are crucial to match the yield data and generate sensible economic implications. We find a 10 basis-point drop in the lower bound lowers the short rate by the same amount, and lowers the 10-year yield by 6 to 8 basis points.