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In search of the liquidity effect

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Author Info

  • Eric M. Leeper
  • David B. Gordon

Abstract

A short-run negative relationship between monetary aggregates and interest rates--the "liquidity effect"--is central to popular, political, and academic discussions of monetary policy. This paper searches for this empirical relationship. We use monthly U.S. data since 1954 to ask if the characterization of the liquidity effect is sensitive to: (i) changes in sample period; (ii) conditioning the correlations on additional variables; (iii) assuming money growth is exogenous, and (iv) treating monetary changes as anticipated or unanticipated. ; The correlations change significantly with each of the four variations. We conclude that a successful search for the liquidity effect requires careful identification of private and policy behavior.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 91-17.

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Date of creation: 1991
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Handle: RePEc:fip:fedawp:91-17

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Keywords: Liquidity (Economics);

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References

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  1. Barro, Robert J, 1978. "Unanticipated Money, Output, and the Price Level in the United States," Journal of Political Economy, University of Chicago Press, vol. 86(4), pages 549-80, August.
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  12. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
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  18. Breusch, T S, 1978. "Testing for Autocorrelation in Dynamic Linear Models," Australian Economic Papers, Wiley Blackwell, vol. 17(31), pages 334-55, December.
  19. Melvin, Michael, 1983. "The Vanishing Liquidity Effect of Money on Interest: Analysis and Implications for Policy," Economic Inquiry, Western Economic Association International, vol. 21(2), pages 188-202, April.
  20. Robert J. Barro, 1976. "Unanticipated Money Growth and Unemployment in the United States," Working Papers 234, Queen's University, Department of Economics.
  21. Lawrence J. Christiano, 1991. "Modeling the liquidity effect of a money shock," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 3-34.
  22. Rasche, Robert H., 1987. "M1 -- Velocity and money-demand functions: Do stable relationships exist?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 27(1), pages 9-88, January.
  23. Gibson, William E, 1970. "The Lag in the Effect of Monetary Policy on Income and Interest Rates," The Quarterly Journal of Economics, MIT Press, vol. 84(2), pages 288-300, May.
  24. Leonall C. Andersen & Jerry L. Jordon, 1968. "Monetary and fiscal actions: a test of their relative importance in economic stabilization," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 11-23.
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