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The relationship between the daily and policy-relevant liquidity effects

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  • Daniel L. Thornton

Abstract

The phrase "liquidity effect" was introduced by Milton Friedman (1969) to describe the first of three effects on interest rates caused by an exogenous change in the money supply. The lack of empirical support for the liquidity effect using monthly and quarterly monetary and reserve aggregates data led Hamilton (1997) to suggest that more convincing evidence of the liquidity effect could be obtained with daily data - the daily liquidity effect. This paper investigates the implications of the daily liquidity effect for Friedman's liquidity effect using a more comprehensive model of the Federal Reserve's daily operating procedure than has been previously used in the literature. The evidence indicates that it is no easier to find convincing evidence of a Friedman liquidity effect using daily data than it has been with lower-frequency monthly and quarterly data.

Suggested Citation

  • Daniel L. Thornton, 2010. "The relationship between the daily and policy-relevant liquidity effects," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 73-88.
  • Handle: RePEc:fip:fedlrv:y:2010:i:jan:p:73-88:n:v.92no.1
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    References listed on IDEAS

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    1. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, vol. 59(2), pages 347-370, March.
    2. Daniel L. Thornton, 2004. "Forecasting the Treasury's balance at the Fed," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 23(5), pages 357-371.
    3. Feinman, Joshua N, 1993. "Estimating the Open Market Desk's Daily Reaction Function," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(2), pages 231-247, May.
    4. 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.
    5. Carpenter, Seth & Demiralp, Selva, 2006. "The Liquidity Effect in the Federal Funds Market: Evidence from Daily Open Market Operations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(4), pages 901-920, June.
    6. Bartolini, Leonardo & Bertola, Giuseppe & Prati, Alessandro, 2002. "Day-to-Day Monetary Policy and the Volatility of the Federal Funds Interest Rate," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(1), pages 137-159, February.
    7. Strongin, Steven, 1995. "The identification of monetary policy disturbances explaining the liquidity puzzle," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 463-497, June.
    8. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
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    Cited by:

    1. Crowder, William J., 2012. "The liquidity effect: Evidence from the U.S," Economics Letters, Elsevier, vol. 117(1), pages 315-317.
    2. Dressler, Scott J. & Kersting, Erasmus K., 2015. "Excess reserves and economic activity," Journal of Economic Dynamics and Control, Elsevier, vol. 52(C), pages 17-31.

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    Keywords

    Liquidity (Economics) ; Monetary policy;

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