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The Liquidity Effect in the Federal Funds Market: Evidence from Daily Open Market Operations

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  • Carpenter, Seth
  • Demiralp, Selva

Abstract

We use forecast errors made by the Federal Reserve while preparing open market operations to identify a liquidity effect at a daily frequency in the federal funds market. We find a liquidity effect on most days of the reserve maintenance period in addition to settlement day. The effect is nonlinear; large changes in supply more consistently have a measurable effect than do small changes. In addition, a higher aggregate level of reserve balances in the banking system is associated with a smaller liquidity effect during the maintenance period but a larger liquidity effect on the last days of the period.

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File URL: http://dx.doi.org/10.1353/mcb.2006.0051
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Bibliographic Info

Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 38 (2006)
Issue (Month): 4 (June)
Pages: 901-920

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Handle: RePEc:mcb:jmoncb:v:38:y:2006:i:4:p:901-920

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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References

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  1. Lawrence J. Christiano, 1991. "Modeling the liquidity effect of a money shock," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 3-34.
  2. Selva Demiralp & Dennis Farley, 2003. "Declining required reserves, funds rate volatility, and open market operations," Finance and Economics Discussion Series 2003-27, Board of Governors of the Federal Reserve System (U.S.).
  3. Gali, Jordi, 1992. "How Well Does the IS-LM Model Fit Postwar U.S. Data," The Quarterly Journal of Economics, MIT Press, vol. 107(2), pages 709-38, May.
  4. Adrian R. Pagan & John C. Robertson, 1995. "Resolving the liquidity effect," Proceedings, Federal Reserve Bank of St. Louis, issue May, pages 33-54.
  5. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, vol. 59(2), pages 347-70, March.
  6. Seth Carpenter & Selva Demiralp, 2008. "The Liquidity Effect in the Federal Funds Market: Evidence at the Monthly Frequency," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(1), pages 1-24, 02.
  7. Ben S. Bernanke & Ilian Mihov, 1995. "Measuring Monetary Policy," NBER Working Papers 5145, National Bureau of Economic Research, Inc.
  8. Eric M. Leeper & David B. Gordon, 1991. "In search of the liquidity effect," Working Paper 91-17, Federal Reserve Bank of Atlanta.
  9. Cochrane, John H, 1989. "The Return of the Liquidity Effect: A Study of the Short-run Relation between Money Growth and Interest Rates," Journal of Business & Economic Statistics, American Statistical Association, vol. 7(1), pages 75-83, January.
  10. Hamilton, James D, 1997. "Measuring the Liquidity Effect," American Economic Review, American Economic Association, vol. 87(1), pages 80-97, March.
  11. James A. Clouse & Douglas W. Elmendorf, 1997. "Declining required reserves and the volatility of the federal funds rate," Finance and Economics Discussion Series 1997-30, Board of Governors of the Federal Reserve System (U.S.).
  12. Daniel L. Thornton, 2001. "Identifying the liquidity effect at the daily frequency," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 59-82.
  13. Ben S. Bernanke & Ilian Mihov, 1998. "The Liquidity Effect and Long-Run Neutrality," NBER Working Papers 6608, National Bureau of Economic Research, Inc.
  14. Hamilton, James D, 1996. "The Daily Market for Federal Funds," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 26-56, February.
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