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The Liquidity Effect in the Federal Funds Market: Evidence from Daily Open Market Operations

  • Carpenter, Seth
  • Demiralp, Selva

We use forecast errors made by the Federal Reserve while preparing open market operations to identify a liquidity effect at a daily frequency in the federal funds market. We find a liquidity effect on most days of the reserve maintenance period in addition to settlement day. The effect is nonlinear; large changes in supply more consistently have a measurable effect than do small changes. In addition, a higher aggregate level of reserve balances in the banking system is associated with a smaller liquidity effect during the maintenance period but a larger liquidity effect on the last days of the period.

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File URL: http://dx.doi.org/10.1353/mcb.2006.0051
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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 38 (2006)
Issue (Month): 4 (June)
Pages: 901-920

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Handle: RePEc:mcb:jmoncb:v:38:y:2006:i:4:p:901-920
Contact details of provider: Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. Ben S. Bernanke & Ilian Mihov, 1995. "Measuring monetary policy," Working Papers in Applied Economic Theory 95-09, Federal Reserve Bank of San Francisco.
  2. Adrian R. Pagan & John C. Robertson, 1995. "Resolving the liquidity effect," Proceedings, Federal Reserve Bank of St. Louis, issue May, pages 33-54.
  3. Cochrane, John H, 1989. "The Return of the Liquidity Effect: A Study of the Short-run Relation between Money Growth and Interest Rates," Journal of Business & Economic Statistics, American Statistical Association, vol. 7(1), pages 75-83, January.
  4. James D. Hamilton, 1996. "Measuring the liquidity effect," Working Papers in Applied Economic Theory 96-06, Federal Reserve Bank of San Francisco.
  5. James A. Clouse & Douglas W. Elmendorf, 1997. "Declining required reserves and the volatility of the federal funds rate," Finance and Economics Discussion Series 1997-30, Board of Governors of the Federal Reserve System (U.S.).
  6. Demiralp, Selva & Farley, Dennis, 2005. "Declining required reserves, funds rate volatility, and open market operations," Journal of Banking & Finance, Elsevier, vol. 29(5), pages 1131-1152, May.
  7. Eric M. Leeper & David B. Gordon, 1991. "In search of the liquidity effect," Working Paper 91-17, Federal Reserve Bank of Atlanta.
  8. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, vol. 59(2), pages 347-70, March.
  9. Lawrence J. Christiano, 1991. "Modeling the liquidity effect of a money shock," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 3-34.
  10. Bernanke, Ben S. & Mihov, Ilian, 1998. "The liquidity effect and long-run neutrality," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 49(1), pages 149-194, December.
  11. Gali, Jordi, 1992. "How Well Does the IS-LM Model Fit Postwar U.S. Data," The Quarterly Journal of Economics, MIT Press, vol. 107(2), pages 709-38, May.
  12. Daniel L. Thornton, 2001. "Identifying the liquidity effect at the daily frequency," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 59-82.
  13. 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.
  14. 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.
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