Khóa luận tốt nghiệp Tài chính ngân hàng: Examining the co-movement among short shadow rates during Covid-19

The literature review will alsoexplore the various monetary policy measures implemented by central banks during the pandemic, including quantitative easing, forward guidance, and negativ

"4 UNIVERSITY OF ECONOMICS AND BUSINESS

FACULTY OF FINANCE AND BANKING

Or’

90O-GRADUATION THESIS

EXAMINING THE CO-MOVEMENT AMONG SHORT SHADOW

RATES DURING COVID-19

TEACHER INSTRUCTION : Dr LE HONG THAI STUDENT NAME : NGUYEN PHUONG ANH STUDENT CODE : 19050606

CLASS : QH-2019-E TCNH CLC 1

Hanoi May 2023

I hereby declare that this graduation thesis is my own work, with the support of my

supervisor, and has not copied the work of others This is my own research work The dataand secondary information used in the thesis are sourced and clearly cited

This statement is entirely my responsibility

First and foremost, I would like to express my sincere gratitude to my thesis advisor,

Dr Le Hong Thai, for his guidance, support, and valuable feedback throughout the entireprocess Their expertise and encouragement have been instrumental in the successfulcompletion of this thesis

I would also like to thank the faculty and staff of the University of Economic and

Business, Vietnam National University, especially Faculty of Finance and Banking, who

provided me with the necessary resources, knowledge, and opportunities to pursue myacademic interests and achieve my goals

Furthermore, I would like to express my appreciation to my family and friends for

their unwavering support, love, and encouragement throughout my academic journey

Their belief in me has been a constant source of motivation and inspiration

Last but not least, I would like to thank all the frontline workers, healthcareprofessionals, and essential workers who have been working tirelessly to keep ourcommunities safe during the COVID-19 pandemic Their dedication and sacrifice havebeen an inspiration to me and many others

In conclusion, this thesis would not have been possible without the support andcontribution of all the individuals and organizations mentioned above | am deeply

grateful for their assistance and will always carry their influence with me in my future

endeavors

TABLE OF CONTENTS

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CHAPTER 3: RESEARCH METHODOLOY «5c HH HH rkt 26

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iv

LIST OF ABBREVIATION [Abbreviations — |[Fullname

COVID-19 Coronavirus disease 2019

VAR vector autoregression

FED the US Federal Reserve

GDP Gross Domestic Product

NIRPs negative interest rate policies

TCIS total connectedness indexes

QE quantitative easing

BoE The Bank of England

UAE United Arab Emirates

BoK The Bank of Korea

BIC Bayesian information criterion

NPDC net pairwise directional connectednessSSR Shadow Short Rate

EU UK-European Union

vi

LIST OF TABLES

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vii

LIST OF FIGURES

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viii

CHAPTER 1: INTRODUCTION

1.1 Research background

The COVID-19 pandemic has brought unprecedented challenges to the globaleconomy and financial markets In response, central banks around the world haveimplemented unprecedented monetary policy measures to mitigate the economicimpacts of the pandemic One of the key tools used by central banks is interest rates,which they have cut to record lows or even negative territory in some countries

The COVID-19 pandemic has had a profound impact on the global economy, leading to

an unprecedented disruption of financial markets worldwide The central banks of major

economies have responded to this crisis by introducing a range of monetary policies

aimed at mitigating the economic shock caused by the pandemic As part of these efforts,central banks have reduced interest rates to near-zero levels, leaving little room forfurther rate cuts in the event of future economic shocks As a result, many central bankshave turned to unconventional monetary policy tools, such as quantitative easing andforward guidance, to provide additional support to their economies

One of the challenges faced by policymakers in this environment is assessing theeffectiveness of their monetary policies One way to evaluate the effectiveness ofmonetary policies is to examine the co-movement among short shadow rates during thepandemic Shadow rates are hypothetical interest rates derived from market prices,which can provide insights into the stance of monetary policy

The co-movement among short shadow rates during the pandemic is an importantresearch question because it can help us understand the degree to which monetary

policies have been coordinated across major economies during this crisis If there is a highdegree of co-movement among short shadow rates, it could suggest that central bankshave been acting in a coordinated manner to stabilize global financial markets

Alternatively, if there is a low degree of co-movement among short shadow rates, it could

suggest that central banks have been pursuing divergent policies in response to the

pandemic, potentially leading to destabilizing effects on global financial markets.Previous research has examined the co-movement among short-term interest rates in the

context of global financial crises For example, Eichengreen and Rose (1998) found

evidence of co-movement among short-term interest rates during the 1930s depression,

1

which they interpreted as evidence of a "global liquidity trap." Similarly, Forbes and

Rigobon (2002) found evidence of co-movement among short-term interest rates during

the Asian financial crisis of the late 1990s, which they attributed to coordinated policyresponses by central banks in the region

More recently, several studies have examined the co-movement among short shadowrates during the COVID-19 pandemic Krippner (2020) found evidence of high co-

movement among short shadow rates in G7 countries, which he attributed to coordinated

policy responses by central banks Liu et al (2021) found evidence of high co-movement

among short shadow rates in emerging market economies, which they attributed to

spillover effects from developed economies

However, there are several gaps in the existing literature that this study aims to

address First, most studies have focused on the co-movement among short-term interestrates, rather than shadow rates, which can provide a more nuanced view of monetarypolicy Second, most studies have focused on developed economies, rather thanexamining the co-movement among short shadow rates in a broader range of countries.Finally, most studies have examined the co-movement among short shadow rates duringthe early stages of the pandemic, rather than examining whether this co-movement haspersisted over time

This study aims to fill these gaps in the literature by examining the co-movement

among short shadow rates in a broad range of economies during the COVID-19 pandemic.Specifically, we will examine the extent to which short shadow rates have moved togetheracross different regions, and whether this co-movement has persisted over time Ouranalysis will contribute to a better understanding of the effectiveness of monetarypolicies during the pandemic and provide insights into the degree of coordination amongcentral banks in response to this crisis

analysis could provide insights into the behavior of financial markets during a crisis and

inform policymakers on how to respond to similar events in the future

To achieve this objective, the thesis may use econometric techniques to analyze series data on short shadow rates from various countries The study may also considerfactors such as changes in monetary policy and macroeconomic conditions during thepandemic that could have influenced the co-movement of short shadow rates

time-Overall, the research objective of this graduation thesis is to contribute to our

understanding of how short shadow rates behaved during the COVID-19 pandemic and

what factors may have influenced their co-movement.

1.3 Research questions

Specifically, this thesis plans to answer the following three research questions:

- How have short shadow rates behaved during the COVID-19 pandemic?

- To what extent do short shadow rates co-move with each other during the COVID-19

pandemic?

- What implications do the findings have for policymakers and investors?

1.4 Research scope

- Scope of content: the connectedness among short shadow rates during the COVID-19

period for selected economies or regions

- Scope of space: United States of America, European Union, Japan, United Kingdom,

Switzerland, Canada, Australia, New Zealand and G4 groups

- Scope of time: during the period from January 2n4, 2019 to March 271%, 2023

1.5 Research contributions

Understanding the behavior of short shadow rates during the COVID-19 pandemic:

The thesis can provide insights into how short shadow rates have behaved during thepandemic and how they have co-moved with each other This can help researchers and

policymakers better understand the impact of the pandemic on financial markets and the

economy.

Examining the relationship between short shadow rates and traditional interest rates:

By examining the co-movement among short shadow rates, the thesis can shed light on

the relationship between short shadow rates and traditional interest rates This can helpresearchers and policymakers better understand the transmission mechanism ofmonetary policy.

Developing a methodology for analyzing co-movement among short shadow rates:The thesis can contribute to the development of a methodology for analyzing the co-movement among short shadow rates This can be useful for future research on short

shadow rates and their relationship with traditional interest rates.

Providing insights for investors and financial institutions: The thesis can provide

insights for investors and financial institutions on the behavior of short shadow rates

during the pandemic This can help them make more informed investment decisions and

manage risk more effectively

Overall, the graduation thesis "Examining the Co-movement Among Short ShadowRates during COVID-19" can make important contributions to the understanding of shortshadow rates, their behavior during the pandemic, and their relationship with traditional

interest rates.

1.6 Structure of the thesis

The thesis begins with a literature review of the relevant literature on shadow rates

and their use in analyzing monetary policy (Chapter 2) The literature review will alsoexplore the various monetary policy measures implemented by central banks during the

pandemic, including quantitative easing, forward guidance, and negative interest rates

Chapter 3 will introduce the research data and the methodology The next section ofthe thesis (Chapter 4) will present an empirical analysis of the co-movement of shortshadow rates across the nine countries This analysis will be conducted using a vectorautoregression (VAR) model, which allows for the simultaneous analysis of multiple

variables and their interrelationships over time The analysis will explore the degree to

which short shadow rates move together across countries and whether this co-movementhas increased during the pandemic

The final section of the thesis (Chapter 5) will discuss the implications of the findingsfor central bank policy and the broader global economy The discussion will address theextent to which the co-movement of short shadow rates reflects global economic factors

or the transmission of monetary policy across countries The discussion will also consider

the implications of the findings for the effectiveness of monetary policy during the

pandemic and beyond

Overall, this graduation thesis makes a significant contribution to the literature onshadow rates and their role in analyzing monetary policy The findings of this researchhave important implications for policymakers, investors, and academics interested inunderstanding the global economy and financial markets in the context of the COVID-19pandemic

CHAPTER 2: LITERATURE REVIEW

2.1 Theoretical basis

2.1.1 Monetary policy

2.1.1.1 Definition of monetary policy

Mishkin & Eakins (2016) define monetary policy as “Monetary policy is the

management of money and interest rates by central banks to achieve macroeconomicobjectives such as price stability, high employment, and sustainable economic growth”.Cecchetti & Schoenholtz (2018) state “Monetary policy is the process by which themonetary authority of a country controls the supply of money, often targeting an inflationrate or interest rate to ensure price stability and general trust in the currency.” Asfollowing, monetary policy represents: a set of actions and decisions undertaken by acountry’s central bank to regulate and control the money supply, interest rates, exchangerates, and other monetary tools to influence financial and economic activities within itsjurisdiction The description of the concept of monetary policy is stated on the FederalReserve Bank of San Francisco’s website: “Monetary policy refers to the actions taken by

a central bank to influence the availability and cost of money and credit to help promotenational economic goals It is aimed at promoting maximum employment, stable prices,and moderate long-term interest rates.” The ultimate goal of monetary policy is to achievemacroeconomic objectives, such as price stability, economic growth, inflation control, and

financial stability

Monetary policy is a powerful tool used by governments and central banks to managethe economy by influencing the supply and demand of money, credit, and interest rates.According to the book "Monetary Policy and Central Banking" by Carl E Walsh, monetarypolicy refers to "the actions taken by the central bank or other regulatory authorities tomanage the availability, cost, and use of money and credit to achieve specificmacroeconomic goals." These goals typically include controlling inflation, promotingeconomic growth, and maintaining financial stability

In the book "Principles of Economics" by Gregory Mankiw, monetary policy is defined

as "the setting of the money supply and the interest rate by policymakers in the centralbank." The book goes on to explain that the central bank can adjust the money supply bybuying or selling government securities, and can adjust interest rates by changing thediscount rate or the reserve requirement

Another reference for the definition of monetary policy can be found in the book

"Macroeconomics" by Paul Krugman and Robin Wells The authors define monetarypolicy as "the use of the central bank's control over the supply of money to influence theeconomy.” The book emphasizes that the primary goal of monetary policy is to stabilizethe economy by managing inflation, output, and employment

In summary, monetary policy refers to the actions taken by central banks and

governments to manage the supply and demand of money, credit, and interest rates in the

economy This policy is aimed at achieving macroeconomic goals such as controlling

inflation, promoting economic growth, and maintaining financial stability

Central banks typically use a variety of tools to implement monetary policy, which

may include open market operations (buying or selling government securities), discount

rate (the rate at which commercial banks can borrow from the central bank), reserverequirements (the amount of reserves commercial banks are required to hold), andcommunication or forward guidance (indicating the central bank's future policyintentions) These tools are used to influence the supply of money and credit in theeconomy, which in turn affects interest rates, investment, consumption, and overall

economic activity.

One of the most commonly used tools is open market operations, which refers to thebuying or selling of government securities in the open market According to FederalReserve Bank of St Louis, when the central bank buys government securities, it injectsmoney into the economy, which increases the money supply Conversely, when thecentral bank sells government securities, it withdraws money from the economy, whichdecreases the money supply Open market operations are a powerful tool for the centralbank because they can be used to control the amount of reserves that commercial bankshold, which in turn affects the amount of credit that banks can extend to households andbusinesses

Another tool used by central banks is the discount rate, which is the interest rate atwhich commercial banks can borrow from the central bank As Bernanke, et al (2001)state, when the central bank lowers the discount rate, it becomes cheaper for commercialbanks to borrow money, which can encourage them to lend more to households andbusinesses This, in turn, can increase the money supply in the economy Conversely,when the central bank raises the discount rate, it becomes more expensive for

commercial banks to borrow money, which can discourage them from lending and

decrease the money supply.

Reserve requirements are another tool used by central banks to influence the moneysupply, stated by Iqbal (2020) Reserve requirements refer to the amount of reserves thatcommercial banks are required to hold by law When the central bank lowers reserverequirements, commercial banks are able to lend more money and increase the money

supply in the economy Conversely, when the central bank raises reserve requirements,

commercial banks are required to hold more reserves, which can decrease the amount ofmoney they have available to lend and decrease the money supply

Finally, communication or forward guidance is a tool used by central banks to signal

their future policy intentions to the public and financial markets By providing guidance

on their future policy actions, central banks can influence expectations and shape marketreactions For example, if a central bank indicates that it plans to lower interest rates inthe future, this can encourage households and businesses to borrow more and spendmore, which can stimulate economic growth and increase the money supply

Mishkin & Eakins (2012) discusses about central banks and monetary policy in

“Financial markets and institutions” which can be sum up as follow Monetary policy can

be expansionary, aimed at stimulating economic growth and reducing unemployment, orcontractionary, aimed at controlling inflation and preventing economic overheating.Expansionary monetary policy aims to stimulate economic growth and reduceunemployment by increasing the money supply and lowering interest rates This can beachieved through various mechanisms, such as buying government securities (bonds)from the open market, which injects liquidity into the banking system and increases themoney supply Additionally, the central bank may lower the discount rate, which is theinterest rate at which banks can borrow from the central bank, making it cheaper forbanks to access funds and encouraging lending to businesses and individuals

On the other hand, contractionary monetary policy aims to control inflation and

prevent economic overheating by reducing the money supply and raising interest rates

This can be done through mechanisms such as selling government securities from theopen market, which withdraws liquidity from the banking system and reduces the moneysupply The central bank may also raise the discount rate, making it more expensive for

banks to borrow from the central bank and thereby reducing their ability to lend to

businesses and individuals.

The specific mechanisms and decisions regarding buying or selling governmentsecurities and adjusting the discount rate may vary depending on the central bank'spolicy framework and the economic conditions of a particular country These actions arepart of the central bank's efforts to implement monetary policy and achieve its

macroeconomic objectives of promoting economic growth, controlling inflation, and

maintaining price stability The specific strategies and actions undertaken by a centralbank as part of its monetary policy can vary depending on the economic conditions, goals,and preferences of the country or region in question

2.1.1.2 Measuring monetary policyMeasuring monetary policy typically involves analyzing and quantifying the effects ofvarious monetary policy tools and actions on the economy Here are some commonapproaches for measuring monetary policy:

short-term interest rates as a key tool for implementing monetary policy Analysts

often study the impact of changes in interest rates on various economic variables,such as investment, consumption, and inflation, to assess the effectiveness ofmonetary policy, according to Gregory (2020)

Money Supply: Another measure of monetary policy is changes in the moneysupply, which refers to the total amount of money in an economy Central bankscan influence the money supply through various policy tools, such as open marketoperations, reserve requirements, and discount rates Changes in the moneysupply can affect inflation, interest rates, and overall economic activity

Exchange Rates: Exchange rates, which determine the value of one currencyrelative to another, can also be used as an indicator of monetary policy Centralbanks may intervene in foreign exchange markets to influence exchange rates aspart of their monetary policy actions Changes in exchange rates can impactinternational trade, capital flows, and competitiveness of domestic industries

iv Economic Indicators: Economic indicators, such as GDP (Gross Domestic Product),

inflation rate, employment rate, and consumer spending, can also be used tomeasure the impact of monetary policy Changes in these indicators can reflect theeffectiveness of monetary policy in influencing the overall health and performance

of an economy

V Financial Market Variables: Monitoring financial market variables, such as stock

prices, bond yields, and credit spreads, can also provide insights into the effects of

monetary policy Changes in these variables can reflect market expectations andreactions to monetary policy actions

vi Econometric Models: Econometric models, which use statistical techniques to

analyze economic data, can also be used to measure the effects of monetary policy

These models allow economists to estimate the relationships between monetarypolicy variables and various economic outcomes, and assess the impact ofmonetary policy in a quantitative manner

It's worth noting that measuring monetary policy can be complex and challenging due

to the multitude of factors that influence the economy and the potential time lags in theeffects of monetary policy actions Multiple measures and approaches are often used incombination to provide a comprehensive assessment of the impact of monetary policy

2.1.2 Interest rate theory: term structure of interest ratesInterest rate theory refers to the various economic theories and concepts that explainthe determinants and dynamics of interest rates in an economy Interest rates are the cost

of borrowing or the return on lending money, and they play a crucial role in shaping thebehavior of borrowers and lenders, as well as influencing investment, consumption, andoverall economic activity

There are several key theories related to interest rates, including:

i Loanable Funds Theory: According to this theory, interest rates are determined by the

supply and demand for loanable funds in an economy The supply of loanable fundscomes from saving, while the demand for loanable funds comes from borrowing forinvestment or consumption purposes Interest rates adjust to balance the supply anddemand for loanable funds

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ili

iv

Liquidity Preference Theory: This theory, developed by John Maynard Keynes,

suggests that interest rates are influenced by the demand for money, which is

determined by the public's preference for holding money as a liquid asset rather thaninvesting in interest-bearing assets The theory suggests that interest rates aredetermined by the trade-off between the liquidity of money and the return on other

investments

Expectations Theory: This theory posits that interest rates are influenced by

expectations about future interest rates According to this theory, long-term interest

rates are equal to the expected average of short-term interest rates over the same

period If investors expect higher interest rates in the future, long-term interest rates

will be higher than current short-term rates, and vice versa

Market Segmentation Theory: This theory suggests that interest rates are determined

by the supply and demand for specific maturity segments of the bond market, ratherthan by the overall supply and demand for loanable funds This theory argues thatdifferent investors and borrowers have preferences for specific maturity segments ofthe bond market, leading to segmented markets with different interest rates fordifferent maturities

Real Interest Rate Theory: This theory focuses on the relationship between nominalinterest rates and inflation It suggests that real interest rates, which are adjusted forinflation, are the key drivers of borrowing and lending decisions Changes in inflationexpectations and inflationary pressures can influence real interest rates and, in turn,impact nominal interest rates

These are some of the main theories related to interest rates, and economists andpolicymakers use these theories to analyze and understand the dynamics of interest rates

in different economic contexts It's important to note that interest rate theory is a complexand evolving field, and there may be differing viewpoints and debates among economists

regarding the determinants of interest rates

The term structure of interest rates, also known as the yield curve, refers to therelationship between the interest rates of bonds or other fixed-income securities withdifferent maturities It describes the graphical representation of the interest rates on avertical axis against the time to maturity on a horizontal axis The term structure of

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interest rates provides insights into the expectations of market participants about future

interest rates and economic conditions.

The term structure of interest rates can take various shapes, including:

i Normal yield curve: This is the most common shape of the yield curve, where

longer-term interest rates are higher than shorter-longer-term interest rates This implies thatinvestors expect higher interest rates in the future, indicating positive expectations

about the economy's future performance.

ii Inverted yield curve: In this case, shorter-term interest rates are higher than

longer-term interest rates An inverted yield curve is often considered a predictor of aneconomic downturn or recession, as it may signal expectations of lower future interest

rates and economic weakness

iii Flat yield curve: This shape of the yield curve indicates that interest rates across

different maturities are relatively similar A flat yield curve may suggest uncertainty

or lack of clear expectations about future interest rates and economic conditions

The term structure of interest rates is an important concept in finance and economics,

as it can influence investment decisions, borrowing costs, and overall economicconditions It is studied and analyzed by economists, policymakers, and marketparticipants to understand the dynamics of interest rates and their potential implicationsfor financial markets and the broader economy

2.1.3 Factors affecting interest rates

Factors affecting interest rates: Various economic, financial, and policy factors thatinfluence the level and direction of interest rates, including inflation expectations, centralbank policies, supply and demand dynamics in financial markets, economic conditions,and global economic and geopolitical events, according to Federal Reserve Bank

There are several factors that can affect interest rates, including:

i Monetary policy: The actions taken by central banks to control the money supply

and influence economic conditions can impact interest rates For example, centralbanks may adjust benchmark interest rates, such as the federal funds rate in theUnited States, to control inflation, stimulate economic growth, or stabilize financialmarkets

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iii.

iv.

vi.

Inflation expectations: Expected inflation can influence interest rates If investors

expect higher inflation in the future, they may demand higher interest rates tocompensate for the erosion of purchasing power due to inflation

Economic conditions: The overall health of the economy, including factors such asGDP growth, employment, and consumer spending, can impact interest rates.During periods of economic expansion, interest rates may be higher as demand for

credit increases, while during economic downturns, interest rates may be lower

as central banks seek to stimulate borrowing and spending

Supply and demand for credit: The supply and demand dynamics in credit markets

can affect interest rates When there is a higher demand for credit relative to

supply, interest rates tend to rise, and vice versa Factors such as government

borrowing, corporate borrowing, and individual borrowing can impact the overallsupply and demand for credit

Risk perception: The perceived risk associated with lending or borrowing canimpact interest rates Lenders may demand higher interest rates for loans that areconsidered more risky, such as loans to borrowers with poor credit history orloans for investments with higher risk profiles

Global factors: International economic and geopolitical events can also impact

interest rates Factors such as global economic conditions, exchange rates, and

geopolitical tensions can affect interest rates in different countries and regions.Global financial market fluctuations, the financial situations of major countries

such as the United States and China, and global economic factors such as oil and

gold prices can also affect the interest rates of a country

It's important to note that interest rates are complex and can be influenced by acombination of factors The interplay between these factors can vary over time and canresult in fluctuations in interest rates in different markets and regions

2.2. Literature review

According to He (2017), the rise of crypto assets and wider adoption of distributedledger technologies may point to a shift from an account-based payment system to onethat is value or token based A shift could also portend a change in the way money is

created in the digital age: from credit money to commodity money (He, 2018) In the 20th

13

century, money was based predominantly on credit relationships: central bank money, or

base money, represents a credit relationship between the central bank and citizens (in

the case of cash) and between the central bank and commercial banks (in the case ofreserves) Crypto assets are not based on any credit relationship, are not liabilities of anyentities, and are more like commodity money in nature If crypto assets indeed lead to amore prominent role for commodity money in the digital age, the demand for central bank

money is likely to decline (He, 2018) Otherwise, central banks conduct monetary policy

by setting short-term interest rates in the interbank market for reserves (or clearing

balances they keep with the central bank) If central bank money no longer defines the

unit of account for most economic activities then the central bank’s monetary policy

become irrelevant Dollarization in some developing economies provide an analogy

When a large part of the domestic financial system operates with a foreign currency,monetary policy for the local currency becomes disconnected from the local economy Forthe solution, He (2018) stated that central banks should continue to strive to make fiatcurrencies better and more stable unit of account As IMF Managing Director ChristineLagarde noted in a speech at the Bank of England in 2017, “The best response by centralbanks is to continue running effective monetary policy, while being open to fresh ideasand new demands, as economies evolve.” Modern monetary policy, based on thecollective wisdom and knowledge of monetary policy committee members - andsupported by central bank independence - offers the best hope for maintaining stableunits of account Moreover, central banks should continue to make their money attractivefor use as a settlement vehicle

As specified by Dell’Ariccia et al (2018), unconventional monetary policies have beenquite effective in preventing further financial distress, restoring the functioning offinancial markets, and providing additional monetary accommodation by compressinglong-term interest rates “When the policy rate and thus the yield on short-term bondsare at zero, the central bank can still provide monetary stimulus by supporting long-term

bond prices and thus lowering long-term yields” The research results state that

quantitative easing can be implemented through the direct acquisition of privately issued

securities

The Bank of Japan has purchased not only government bonds, but also corporatebonds, exchange-traded funds, and real-estate investment funds The European Central

14

Bank purchased “covered bonds” (that is, collateralized bonds issued by banks ormortgage lenders) in three different phases between 2009 and 2017, and corporatebonds in the primary and secondary markets starting in June 2016 Purchases of privatesecurities can reduce the borrowing costs faced by private agents and stimulate theeconomy more directly, but they expose the central bank to credit risk and potentiallosses Typically, quantitative easing has been implemented by announcing a specific

timeline and amount of purchases More recently, the Bank of Japan has adopted an

alternative “yield curve control” approach, which sets targets for both short and term yields and adjusts purchases to meet those targets A possible advantage is that ifthe target is credible, market participants may coalesce around it without requiring

long-purchases by the central bank But if the target is not credible, the central bank may be

forced to purchase bonds in very large quantities or further dent its credibility by revisingthe target

On the contrary, the European Central Bank and the Bank of Japan, along with others,have implemented negative interest rates by charging, rather than paying, interest rates

on the reserves that commercial banks hold at the central bank The hope is thatindividual banks will reduce their excess reserves by increasing lending and purchasingother financial assets In this way, the policy seeks to reduce lending rates, increase creditsupply, and boost prices across financial markets The notion that policy interest ratescannot decline below zero derives from the idea that agents would rather hoard cash thandeposit money in accounts that charge interest rates (that is, pay negative interest rates).However, using cash involves significant transaction costs and risks (it can be stolen), sothat mildly negative rates are unlikely to generate major shifts into holding banknotes.Authors also stated that unconventional monetary policies can contribute to financialstability if lower interest rates help to stimulate the economy and improve borrowers’ability to stay current with their loans However, concerns have been raised about sideeffects that might endanger financial stability, even when unconventional monetarypolicy is successful in stimulating the economy These concerns can be broadly dividedinto five sets of arguments: when long-term securities purchases and forward guidance

flatten the yield curve by compressing term premia, they put pressure on bank

profitability (Borio et al,2015; Borio & Gambacorta, 2017); the compression in safe yieldsfrom monetary easing induces financial intermediaries to move toward riskier assets; a

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low interest rate environment may reduce incentives for banks to recognize and write off

nonperforming loans (Hoshi et al 2008); increasing asset prices and reducing volatility,

central bank purchases may lead to the build-up of asset-price deviations from theirfundamentals and trigger a later sharp asset-price correction, this may also createliquidity risks in the nonbank financial sector, as investors may become too complacent(ECB 2017); and critics of unconventional policies have also warned that when central

banks stray from their traditional way of conducting monetary policy, they might

jeopardize their hard-fought independence

The European Central Bank’s response to the crisis and unconventional monetarypolicy implementation can be divided in three phases First, between September 2008

and the end of 2009, the European Central Bank focused on supporting the banking

sector, using instruments which can be categorized as part of a central bank’s function as

“lender of last resort.” Second, during the sovereign-debt crisis of several euro areacountries between early-2010 and late-2012, the European Central Bank purchasedgovernment bonds to restore market functioning and the transmission mechanism ofmonetary policy Third, starting in mid-2013, the European Central Bank implemented amore aggressive combination of forward guidance, large-scale asset purchases, negativeinterest rates, and targeted credit supply policies (Dell’Ariccia et aL, 2018) Empirical

researchers have used a variety of econometric tools to measure the effects of the

European Central Bank policy measures In general, the literature finds significant effects

on government bond yields from unconventional monetary policy actions undertaken bythe European Central Bank The Outright Monetary Transactions reduced two-yeargovernment bond yields by 200 basis points in Italy and Spain, 500 basis points inPortugal and Ireland, and 1,000 basis points in Greece The decline can be attributed to adecline in default risk, reduced redenomination risk, and reduced market segmentation

by increasing liquidity in distressed markets

Some studies confirm the effects of actions of the European Central Bank onperipheral Europe government bonds, although perhaps with smaller estimated effects(Fratszcher et al, 2016) Other analyses have focused on the credit effects of the EuropeanCentral Bank’s programs Ferrando et al (2015) study the effect of the Outright MonetaryTransactions announcement on small and medium enterprises’ access to credit They findthat the probability of being credit-constrained in peripheral euro countries declined by

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6.4 percent due to the announcement Arce et al (2017) find that the Corporate Sector

Purchase Program and Targeted Longer-Term Refinancing Operations increased bond

issuance by large corporations, as well as bank credit to smaller corporations in Spain,thus providing support to the credit reallocation hypothesis The unconventionalmonetary policies of the European Central Bank clearly affected financial variables Butthis connection is obviously harder to establish because macroeconomic variables are

slower-moving and do not lend themselves to event studies The effects of the negative

interest rate policies (NIRPs) are harder to quantify because the European Central Bankand other macroeconomic policymakers undertook other measures during the sameperiod However, evidence on the behavior of government yields and lending rates

suggests that negative interest rates operate very much like interest rate cuts when these

are in positive territory.

Since the beginning of the global financial crisis, unconventional monetary stimulus

in the United Kingdom has passed through three main phases First, large-scalequantitative easing programs between 2009 and 2012 sought to halt the recession andsupport the economic rebound Second, forward guidance announcements in 2013 and

2014 clarified the intention of the Bank of England not to raise policy rates Third, anadditional round of quantitative easing occurred when the United Kingdom voted to leavethe European Union in 2016 In Japan, the initial monetary response to the global financialcrisis was relatively weak, involving forward guidance announcements between 2010and 2012 supported by limited asset purchases The Bank of Japan delivered much

stronger monetary stimulus after the election of Prime Minister Shinzo Abe in 2012, by

adopting a 2 percent inflation target and launching very large quantitative easingprograms in 2013 and 2014 In 2016, the Bank of Japan entered a third phase of monetarystimulus by introducing the “yield curve control” framework and charging negativeinterest rates on central bank reserves

Using the TVP-VAR-based model, Antonakakis et al (2019) observe that overallmonetary policy spillovers do not change dramatically between the unconventionalperiod and conventional era, as indicated by both total connectedness indexes (TCIs), the

US is the dominant transmitter of spillovers during the unconventional US monetarypolicy era, while a net receiver of spillovers in the conventional US monetary policy era

In other words, the introduction of quantitative easing in the US can be associated with a

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significant increase in international monetary policy spillovers originating from the US.

“These results have important policy implications in the sense that, during episodes of

severe crises the design of monetary policy could reduce the impact other countries'monetary policy has on domestic monetary policy In other words, there could be possiblegains from coordinating monetary policy decisions, especially in the wake ofextraordinary situations like those observed during the recent global financial and the

European debt crises” (Antonakakis et al., 2019).

The interest rates of different countries may vary depending on various factors, such

as the level of economic growth, inflation rate, political and financial conditions, and thedemand for borrowing and lending by organizations and individuals Monetary policies

and economic conditions of each country also affect the interest rates of that country

Therefore, the interest rates of different countries are often not the same and may change

economies and financial markets, there has been a limited amount of research on the

behavior of short shadow rates during this time

To date, there has been no research conducted on the co-movement among shortshadow rates during the COVID-19 pandemic This is a significant gap in the literature, asthe pandemic has created unique economic conditions that have had a profound impact

on financial markets and the global economy as a whole As such, there is a need forfurther research to explore the behavior of short shadow rates during the pandemic, aswell as the mechanisms underlying their co-movement

In addition to the lack of research on short shadow rates during the COVID-19pandemic, there are also several other gaps in the literature For example, there is a needfor further research on the impact of policy coordination among central banks on shortshadow rates While the current study suggests that coordinated policy action may benecessary during times of crisis, further research is needed to explore this relationship inmore detail

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Furthermore, while the current study analyzed data from several countries, there is a

need for more comprehensive research that includes a larger number of countries and a

longer time period This would provide a more complete understanding of the movement among short shadow rates and the factors that influence their behavior over

co-time.

Overall, the literature on the co-movement among short shadow rates is still in its

early stages, and there are several important gaps that need to be addressed The lack of

research on short shadow rates during the COVID-19 pandemic is particularly significant,

as this is a unique time that has created unprecedented economic conditions Therefore,further research is needed to explore the behavior of short shadow rates during the

pandemic, as well as to fill other gaps in the literature and provide a more complete

understanding of this important financial indicator

2.4 Monetary policy responses of countries around the world during COVID-19pandemic

During the COVID-19 pandemic, countries around the world implemented a mix ofmonetary and fiscal policies to address the economic challenges posed by the crisis.Monetary policy involves actions taken by central banks to influence the money supply,interest rates, and borrowing conditions in an economy, while fiscal policy involves theuse of government spending, taxation, and borrowing to manage the economy, according

to International Monetary Fund and the World Bank

Monetary Policy Measures:

i Interest Rate Cuts: Many central banks implemented interest rate cuts to support

liquidity in financial markets, stimulate borrowing and spending, and ease thefinancial burden on households and businesses

ii Liquidity Provision: Central banks also provided liquidity to financial institutions

through various mechanisms, such as open market operations, discount windowlending, and term lending facilities, to ensure smooth functioning of financial marketsand support credit availability

iii Asset Purchase Programs: Some central banks implemented large-scale asset

purchase programs, commonly known as quantitative easing (QE), to provide

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Fiscal Policy Measures:

Government Spending: Many countries implemented increased government spending

to support healthcare systems, provide direct support to households and businesses,and stimulate economic activity in sectors that were severely impacted by the

pandemic, such as tourism, hospitality, and aviation.

Tax Relief: Governments provided tax relief measures, such as tax credits, deferrals,and exemptions, to alleviate the financial burden on individuals and businesses and

support economic recovery.

Income Support: Many countries implemented income support programs, such as

unemployment benefits, wage subsidies, and cash transfers, to provide temporaryrelief to workers who lost their jobs or experienced income loss due to the pandemic.Business Support: Governments implemented various measures to supportbusinesses, such as loan guarantees, grants, and subsidies, to help them stay afloatand maintain employment during the crisis

The specific mix and magnitude of monetary and fiscal policies implemented duringthe COVID-19 pandemic varied among countries, depending on their economic and fiscal

conditions, policy priorities, and the severity of the pandemic's impact

A comparison of research on government responses to the COVID-19 pandemic,including monetary policy, can be summarized as follows:

i

11.

Monetary policy actions: Governments and central banks may implement monetarypolicy measures such as cutting interest rates, buying bonds, providing liquidity tofinancial markets, or implementing asset purchase programs to support the economyand maintain financial stability during the COVID-19 pandemic Research ongovernment responses can analyze the importance, impact, and effectiveness ofmonetary policy measures in mitigating the negative impacts of the pandemic on the

economy and people's livelihoods

Monetary policy and overall economic impact: Monetary policy can have significantimpacts on the overall economy, including affecting business activity, credit,investment, consumption, exchange rates, and the overall level of absorption andeconomic activity during the COVID-19 pandemic Research on government responses

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can provide assessments of the role of monetary policy in supporting the economyand maintaining financial stability in the context of the COVID-19 pandemic, whileanalyzing the impacts of specific monetary policy measures on specific economic

sectors.

iii Interplay between monetary policy and fiscal policy: Research on government

responses to the COVID-19 pandemic may also examine the interaction between

monetary policy and fiscal policy measures Fiscal policy measures, such as

government spending and taxation, can complement or interact with monetary policymeasures in influencing the overall economy during the pandemic Understanding theinterplay between monetary policy and fiscal policy is important in analyzing the

effectiveness of government responses and policy coordination in addressing the

economic impacts of the pandemic

It's worth noting that research on government responses to the COVID-19 pandemicand monetary policy is a dynamic and ongoing field, and findings may continue to evolve

as the pandemic and policy responses unfold

The process of lowering interest rates in different countries may vary and depends oneconomic conditions, inflationary pressures, growth forecasts, and other factors.Typically, countries have monetary policy management agencies, such as central banks,

that hold regular meetings to assess the economic situation and make decisions on

interest rates.

Generally, interest rates are lowered by central banks reducing their policy rates orkey policy rates The policy rate is the interest rate that the central bank applies to credittransactions with commercial banks, while the key policy rate is the interest rate thatcommercial banks apply to loans or deposits for their customers The scale and extent ofinterest rate cuts depend on the economic circumstances and monetary policy of each

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Many central banks, including the Federal Reserve in the United States, the European

Central Bank, the Bank of England, and the Bank of Japan, implemented significantinterest rate cuts in early 2020 in response to the economic challenges posed by thepandemic Interest rate cuts were aimed at supporting liquidity in financial markets,stimulating borrowing and spending, and easing the financial burden on households andbusinesses

It's important to note that the impact of interest rate cuts on the economy depends on

a range of factors, including the effectiveness of monetary policy transmissionmechanisms, the overall economic conditions, and the availability of other policy tools.The interest rate cuts during the COVID-19 pandemic were part of broader monetary

policy measures undertaken by central banks to address the unprecedented challenges

posed by the global health crisis

To mitigate the negative impacts of the COVID-19 pandemic in recent times, countriesaround the world have generally implemented monetary and fiscal policies throughcontinuous interest rate cuts and massive stimulus packages to revive their economiesthat have been stalled due to lockdown measures and widespread infections among theworkforce

In response to the COVID-19 pandemic, the US Federal Reserve (FED) has repeatedlycut its benchmark interest rate to 0% in just a few days in the first half of March 2020,accompanied by massive money injections into the struggling economy amounting totrillions of US dollars On March 3, the FED lowered interest rates by 0.5 percentagepoints, the largest cut since December 2018 This was the first time the FED decided tocut interest rates outside of a formal meeting since the 2008 financial crisis and the fifthemergency interest rate cut in the past 50 years Subsequently, on March 15, the FEDannounced a second interest rate cut amidst the COVID-19 outbreak spreading acrossmany states in the US The FED lowered interest rates by one percentage point to a target

range of 0-0.25% due to concerns that the disease would impact economic activities in

the near future and pose risks to economic prospects

The Bank of England (BoE) also cut its benchmark interest rate by 50 basis points to0.25% on March 11 to boost the economy of the country This was the first time the BoEdecided to lower interest rates since August 2016

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