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Regime switching in the dynamic relationship between the federal funds rate and nonborrowed reserves

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  • Chan Huh
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    Abstract

    This paper examines the dynamic relationship between changes in the funds rate and nonborrowed reserves within a reduced form framework that allows the relationship to have two distinct patterns over time. A regime switching model a la Hamilton (1989) is estimated. The two regimes are different in such characteristics as average changes in the interest rate, and volatility. The historical aerate of the API inflation rate is significantly higher in the high growth and more volatile regime. Innovations in money growth are associated with a strong anticipated inflation effect in the high inflation regime, and a moderate liquidity effect in the low inflation regime. Furthermore, the liquidity effect becomes stronger when the economy leaves a low inflation regime period and enters a high inflation regime period. The converse also holds. The anticipated inflation effect becomes stronger upon switching from a low to high inflation regime.

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    File URL: http://www.federalreserve.gov/pubs/ifdp/1996/536/ifdp536.pdf
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    Bibliographic Info

    Paper provided by Federal Reserve Bank of San Francisco in its series Working Papers in Applied Economic Theory with number 95-11.

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    Date of creation: 1995
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    Handle: RePEc:fip:fedfap:95-11

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    Keywords: Federal funds market (United States) ; Inflation (Finance) ; Monetary policy - United States ; Bank reserves;

    References

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    1. LeRoy, Stephen F, 1984. "Nominal Prices and Interest Rates in General Equilibrium: Money Shocks," The Journal of Business, University of Chicago Press, vol. 57(2), pages 177-95, April.
    2. Garcia, Rene, 1998. "Asymptotic Null Distribution of the Likelihood Ratio Test in Markov Switching Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 763-88, August.
    3. Pagan, A.R. & Robertson, J.C., 1994. "Resolving the Liquidity Effect," Papers 277, Australian National University - Department of Economics.
    4. Leeper, Eric M. & Gordon, David B., 1992. "In search of the liquidity effect," Journal of Monetary Economics, Elsevier, vol. 29(3), pages 341-369, June.
    5. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The effects of monetary policy shocks: evidence from the flow of funds," Proceedings, Federal Reserve Bank of Dallas, issue Apr.
    6. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
    7. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The Effects of Monetary Policy Shocks: Some Evidence from the Flow of Funds," NBER Working Papers 4699, National Bureau of Economic Research, Inc.
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    Cited by:
    1. Chan Huh, 1996. "Regime switching in the dynamic relationship between the federal funds rate and innovations in nonborrowed reserves," International Finance Discussion Papers 536, Board of Governors of the Federal Reserve System (U.S.).

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