The liquidity effect for open market operations
The liquidity effect is the negative relationship between the supply of federal funds and the overnight federal funds rate. Deviations of the federal funds rate from its target can be interpreted as demand innovations for federal funds. Permanent adjustments to demand are modeled as an unobserved component and estimated using the Kalman filter to identify liquidity effects. The demand-based approach for identifying the liquidity effect contrasts previous work which concentrates on errors forecasting the supply of federal funds. This paper finds a liquidity effect several times larger than that from previous studies, indicating the market for federal funds is less liquid than previously thought. The effect of a $1 billion increase in open market operations over a 1-week period is a decrease of the federal funds rate by about 12 basis points.
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Volume (Year): 35 (2011)
Issue (Month): 12 ()
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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Daniel L. Thornton, 2007.
"Open market operations and the federal funds rate,"
Federal Reserve Bank of St. Louis, issue Nov, pages 549-570.
- 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.
- Thornton, Daniel L., 2004. "The Fed and short-term rates: Is it open market operations, open mouth operations or interest rate smoothing?," Journal of Banking & Finance, Elsevier, vol. 28(3), pages 475-498, March.
- Simon Gilchrist, 2001. "Identifying the liquidity effect at the daily frequency (commentary)," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 59-82.
- Daniel L. Thornton, 2001. "Identifying the liquidity effect at the daily frequency," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 59-82.
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- Carpenter, Seth & Demiralp, Selva, 2006.
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Blackwell Publishing, vol. 38(4), pages 901-920, June.
- Seth B. Carpenter & Selva Demiralp, 2004. "The liquidity effect in the federal funds market: evidence from daily open market operations," Finance and Economics Discussion Series 2004-61, Board of Governors of the Federal Reserve System (U.S.).
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American Economic Association, vol. 87(1), pages 80-97, March.
- anonymous, 2004. "Domestic open market operations during 2004," Annual Report Domestic Open Market Operations, Federal Reserve Bank of New York, pages -.
- Judson, Ruth A. & Klee, Elizabeth, 2010. "Whither the liquidity effect: The impact of Federal Reserve open market operations in recent years," Journal of Macroeconomics, Elsevier, vol. 32(3), pages 713-731, September.
- Daniel L. Thornton, 2006. "The daily liquidity effect," Working Papers 2006-020, Federal Reserve Bank of St. Louis.
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