Shadow puppets of monetary policy: A historical reassessment of US transmission mechanisms

This paper reexamines the transmission of US monetary policy in an environment characterized by frequent encounters with the effective lower bound (ELB) and increasing reliance on unconventional policy tools. Using quarterly data from 2004 to 2025, the analysis estimates a six-variable vector autoregression with the Wu–Xia shadow rate as the policy indicator and complements it with state-dependent local projections to test for differences in propagation across policy regimes. The results show that shadow-rate shocks generate sizable and precisely estimated effects on output, house prices, and fiscal aggregates, whereas comparable shocks identified using the federal funds rate produce much weaker responses. The impulse responses also suggest that once policy stance is measured using the shadow rate, the marginal propagation of monetary shocks appears broadly similar inside and outside the ELB. These findings highlight the growing importance of long-term yields, credit spreads, and balance-sheet channels in modern US monetary transmission. Future work should measure the stance of monetary policy using term-structure-based indicators —such as shadow rates, in order to accurately characterize policy transmission in environments where the effective lower bound is frequently binding.