The estimation of dynamic term structure models (DTSMs) turns out to be challenging in the presence of a small sample. It is exacerbated if the sample is characterized by a prolonged period of low interest rates near a time-varying effective lower bound. These challenges all weigh heavily when estimating a DTSM for the euro area OIS yield curve. Against this background, we propose a shadow-rate term structure model (SRTSM) that includes a time-varying effective lower bound and accounts for the spread between the policy and short-term OIS rate. It also allows for future changes in the effective lower bound and incorporates survey information. The model allows to adequately assess short-term monetary policy rate expectations and it generates far-distant rate expectations that are correlated with an estimated equilibrium nominal short rate derived from a macroeconomic model setup. Our results also highlight the signaling channel of non-standard monetary policy shocks in the run-up to asset purchases identified based on a non-linear high-frequency external instrument approach. Our model outperforms DTSM specifications without above modeling features from a statistical and economic perspective. We confirm our findings employing a Monte Carlo simulation.

This paper examines the importance of central bank communication in ensuring the effectiveness of monetary policy and in underpinning the credibility, accountability and legitimacy of independent central banks. It documents how communication has become a monetary policy tool in itself; one example of this being forward guidance, given its impact on inflation expectations, economic behaviour and inflation. The paper explains why and how consistent, clear and effective communication to expert and non-expert audiences is essential in an environment of an ever-increasing need by central banks to reach these audiences. Central banks must also meet the demand for more understandable information about policies and tools, while at the same time overcoming the challenge posed by the wider public's rational inattention. Since the European Central Bank was established, the communications landscape has changed dramatically and continues to evolve. This paper outlines how better communication, including greater engagement with the wider public, could help boost people's understanding of and trust in the Eurosystem.

Research QuestionDynamic term structure models face significant econometric challenges, which are related to the high persistence of interest rates. In the euro area, further difficulties arise from a small sample size and a prolonged period of interest rates at or near the effective lower bound. These data features make the model results and thus the information extracted from the yield curve sensitive to modeling and estimation methods. We aim at developing a euro area term structure model that produces a good model fit and generates economically plausible short rate expectations that can be used for policy analysis. ContributionWe propose a non-linear ('shadow-rate') term structure model for the euro area overnight index swap (OIS) yield curve which includes a lower bound specification that allows for current as well as future changes in the effective lower bound. Our model also accounts for the spread between the short rate and the deposit facility rate as observed in the data. Most importantly, we incorporate survey information on interest rate forecasts into our model to better pin down the expected future path of the short rate, which is important when decomposing interest rates and deriving monetary policy expectations from the yield curve. We also empirically asses the effects of conventional and unconventional monetary policy measures on the components of the OIS curve by explicitly accounting for the non-linearities associated with the effective lower bound. ResultsThe estimated model allows to adequately assess short-term monetary policy expectations. The model-implied most likely path of the short rate follows a trajectory which is in line with survey forecasts and which is consistent with the intended policy rate path of the ECB's Governing Council according to its forward guidance. At more distant horizons rate expectations correlate with an estimated equilibrium nominal short rate. Our analysis also highlights the signaling channel of non-standard monetary policy in the run-up to the Eurosystem's sovereign bond purchases. Our preferred model outperforms alternative modeling specifications in terms of economic plausibility and model fit. Simulations confirm that survey information is key to determine expectations on interest rates priced into the yield curve.