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In search of the liquidity effect

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  • 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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File URL: http://www.federalreserve.gov/pubs/ifdp/1991/403/ifdp403.pdf
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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 403.

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Date of creation: 1991
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Handle: RePEc:fip:fedgif:403

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Keywords: Liquidity (Economics);

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References

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  1. Stokes, Houston H & Neuburger, Hugh, 1979. "The Effect of Monetary Changes on Interest Rates: A Box-Jenkins Approach," The Review of Economics and Statistics, MIT Press, vol. 61(4), pages 534-48, November.
  2. Christopher A. Sims, 1982. "Policy Analysis with Econometric Models," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 13(1), pages 107-164.
  3. Christina D. Romer and David H. Romer., 1989. "Does Monetary Policy Matter? A New Test in the Spirit of Friedman and Schwartz," Economics Working Papers 89-107, University of California at Berkeley.
  4. Grossman, Sanford & Weiss, Laurence, 1983. "A Transactions-Based Model of the Monetary Transmission Mechanism," American Economic Review, American Economic Association, vol. 73(5), pages 871-80, December.
  5. Allan H. Meltzer, 1963. "The Demand for Money: The Evidence from the Time Series," Journal of Political Economy, University of Chicago Press, vol. 71, pages 219.
  6. Robert H. Rasche, 1990. "Demand functions for measures of U.S. money and debt," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 113-172.
  7. Litterman, Robert B & Weiss, Laurence M, 1985. "Money, Real Interest Rates, and Output: A Reinterpretation of Postwar U.S. Data," Econometrica, Econometric Society, vol. 53(1), pages 129-56, January.
  8. 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.
  9. Gibson, William E, 1970. "Interest Rates and Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 78(3), pages 431-55, May-June.
  10. Christopher A. Sims, 1986. "Are forecasting models usable for policy analysis?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-16.
  11. Goodfriend, Marvin, 1991. "Interest rates and the conduct of monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 34(1), pages 7-30, January.
  12. Bryant, R.C., 1991. "Model Representations of Japanese Monetary Policy," Papers 84, Brookings Institution - Working Papers.
  13. Robert J. Barro & Mark Rush, 1980. "Unanticipated Money and Economic Activity," NBER Chapters, in: Rational Expectations and Economic Policy, pages 23-73 National Bureau of Economic Research, Inc.
  14. Fair, Ray C, 1978. "The Sensitivity of Fiscal Policy Effects to Assumptions about the Behavior of the Federal Reserve," Econometrica, Econometric Society, vol. 46(5), pages 1165-79, September.
  15. Breusch, T S, 1978. "Testing for Autocorrelation in Dynamic Linear Models," Australian Economic Papers, Wiley Blackwell, vol. 17(31), pages 334-55, December.
  16. Barro, Robert J, 1977. "Unanticipated Money Growth and Unemployment in the United States," American Economic Review, American Economic Association, vol. 67(2), pages 101-15, March.
  17. Barro, Robert J., 1978. "Unanticipated Money, Output, and the Price Level in the United States," Scholarly Articles 3450988, Harvard University Department of Economics.
  18. Lawrence J. Christiano, 1991. "Modeling the liquidity effect of a money shock," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 3-34.
  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. 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.
  21. 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.
  22. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
  23. Cooley, Thomas F & LeRoy, Stephen F, 1981. "Identification and Estimation of Money Demand," American Economic Review, American Economic Association, vol. 71(5), pages 825-44, December.
  24. Ralph C. Bryant, 1991. "Model Representations of Japanese Monetary Policy," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 9(2), pages 11-61, September.
  25. Stephen M. Goldfeld, 1973. "The Demand for Money Revisited," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 4(3), pages 577-646.
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