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Daniel L. Thornton - One of the best experts on this subject based on the ideXlab platform.
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The relationship between the daily and policy-relevant Liquidity Effects
Review, 2010Co-Authors: Daniel L. ThorntonAbstract: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.
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The daily and policy-relevant Liquidity Effects
2007Co-Authors: Daniel L. ThorntonAbstract: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 data using various monetary and reserve aggregates led Hamilton (1997) to suggest that more convincing evidence of the Liquidity Effect could be obtained using daily data – the daily Liquidity Effect. This paper investigates the implications of the daily Liquidity Effect for Friedman’s Liquidity Effect using a comprehensive model of the Fed’s daily operating procedure. The evidence indicates that it is no easier to find convincing evidence of a Friedman’s Liquidity Effect using daily data than it has been using lower frequency data. JEL Classification: E40, E52
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The Daily Liquidity Effect
SSRN Electronic Journal, 2006Co-Authors: Daniel L. ThorntonAbstract:Motivated, on the one hand, by the belief that the Fed controls the short-term rate through open market operations, and on the other, by "the lack of convincing proof that this is what happens," Hamilton (1997) suggested that more convincing evidence of the Liquidity Effect could be obtained with the use of high-frequency (daily) data. Thornton*s (2001a) detailed analysis of Hamilton*s results and evidence using both Hamilton*s and an alternative methodology indicates a quantitatively unimportant daily Liquidity Effect. Recently, Carpenter and Demiralp (2006) report "clear evidence" of a daily Liquidity Effect using a more comprehensive reserve-supply-shock measure than that used by Hamilton. This paper investigates the daily Liquidity Effect using Carpenter and Demiralp*s new measure.
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Open Market Operations and the Federal Funds Rate
SSRN Electronic Journal, 2005Co-Authors: Daniel L. ThorntonAbstract:The Fed's ability to control the federal funds rate stems from its ability to alter the supply of Liquidity in the overnight market through open market operations. This paper uses daily data compiled by the author from the records of the Trading Desk of the Federal Reserve Bank of New York over the period March 1, 1984, through December 31, 1996, to analyze the Desk's use of its operating procedure in implementing monetary policy, and the extent to which open market operations affect the federal funds rate-the Liquidity Effect. I find that operating procedure was used to guide daily open market operations; however, there is little evidence of a Liquidity Effect at the daily frequency and even less evidence at lower frequencies. Consistent with the absence of a Liquidity Effect, open market operations appear to be a relatively unimportant source of Liquidity to the federal funds market.
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Identifying the Liquidity Effect at the daily frequency
Review, 2001Co-Authors: Daniel L. ThorntonAbstract:It is widely believed that the Fed controls the overnight federal funds rate, and thereby other short-term interest rates, through open market operations.1 The Fed sells government securities, reducing the supply of reserves relative to demand, when it wants to raise the funds rate. Similarly, it purchases securities when it wants the funds rate to fall. The change in the short-term interest rates brought about by the exogenous policy actions of the monetary authority is referred to as the Liquidity Effect. By many accounts—public and professional—the Fed’s use of this procedure is responsible for most, if not all, lower frequency variation in the federal funds rate and, thereby, other short-term interest rates at least since the late 1980s. Despite the widespread belief in the Fed’s ability to control short-term interest rates through open market operations, attempts to estimate the Liquidity Effect—using a variety of approaches—generally have been unsuccessful.2 Many analysts attribute this lack of success to the inability of economists to isolate the exogenous policy actions of the Fed. Hamilton (1997) notes that, most often, the Fed adjusts its policy instrument in response to new information about current or future values of output, inflation, the exchange rate, or other variables. Because of this, Hamilton argues that “the correlation between such ‘policy innovations’ and the future level of output of necessity mixes together the Effect of policy on output with the Effect of output on policy” (p. 80). This problem tends to be more severe when the monetary aggregates used to estimate the Liquidity Effect are only loosely associated with the policy actions of the Fed or when the data are averaged over a period of a month or more. Hamilton suggests that “a more convincing measure of the Liquidity Effect” can be obtained by estimating the “instantaneous consequences of an open market purchase. For daily data, Federal Reserve accounting and Trading Desk procedures suggest some quite plausible identifying assumptions that can be used to measure the instantaneous Liquidity Effect” (pp. 80-81). Specifically, Hamilton estimates the response of the funds rate to reserve supply shocks that are analogous to those that the Fed could create through open market operations. Hamilton finds that the funds rate responds significantly to reserve supply shocks, but only on the last two days of the maintenance period, and that the response is economically significant only on settlement Wednesdays. I model the reserve market based on the Fed’s operating procedure and show why the Liquidity Effect cannot be identified using Hamilton’s methodology. Consistent with this analysis, I show that Hamilton’s settlement-day result is fragile and due to a few settlement Wednesdays when there were unusually large changes in the funds rate. In addition, I show that there is no Liquidity Effect using his methodology for sample periods before and after his. I then suggest an alternative approach to estimating the Liquidity Effect at the daily frequency. Specifically, I argue that the Liquidity Effect can be identified by estimating the change in nonborrowed reserves associated with changes in the Fed’s target for the federal funds rate. If the Fed controls the federal funds rate by changing the funds rate target, reserves should change when the target is changed. Estimates of this model using data prior to 1994 suggest that, while the Fed undertakes open market operations consistent with changing the funds rate when the funds rate target is changed, the size of the actions is relatively small compared with stochastic fluctuations in reserves. One possible interpretation
Tomoyuki Nakajima - One of the best experts on this subject based on the ideXlab platform.
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Monetary policy with sticky prices and segmented markets
Economic Theory, 2006Co-Authors: Tomoyuki NakajimaAbstract:We consider a sticky-price model with segmented asset markets, and examine its implications for monetary policy. Our finding is, first, that the response of the money supply growth rate to a money demand shock required to stabilize inflation is not affected by the existence of a Liquidity Effect, but the response of the nominal interest rate is. Second, when the monetary authority adopts a Taylor rule, whether or not it should be active to obtain local determinacy of equilibria depends on the existence of a Liquidity Effect. Our results suggest that the monetary authority should be careful about the existence and the degree of a Liquidity Effect particularly when the nominal interest rate is used as the policy instrument.
Javier Vallés - One of the best experts on this subject based on the ideXlab platform.
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Endogenous monetary policy and the Liquidity Effect
Spanish Economic Review, 2004Co-Authors: Javier Andrés, J. D. Lopez-salido, Javier VallésAbstract:We compare the transmission mechanism of exogenous and endogenous monetary policies in a calibrated small open economy model with nominal and real rigidities. Under an exogenous monetary policy rule it takes implausible values of the intertemporal elasticity of substitution and the price adjustment costs to generate the Liquidity and overshooting Effects. Endogenous rules with strong feedback to inflation and output help to reproduce the response of the nominal interest and exchange rates to unanticipated monetary policy shocks that characterize the transmission mechanism of standard sticky price models. The liquidty and overshooting Effects are always obtained when the model is augmented with a Taylor interest rate rule.
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Intertemporal Substitution and the Liquidity Effect in a Sticky Price Model
European Economic Review, 2002Co-Authors: Javier Andrés, J. D. Lopez-salido, Javier VallésAbstract:The Liquidity Effect, defined as a decrease in nominal interest rates in response to a monetary expansion, is a major stylized fact of the business cycle. This paper seeks to understand under what conditions such an Effect can be explained in a general equilibrium model with sticky prices and capital adjustment costs.
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Intertemporal Substitution and the Liquidity Effect in a Sticky Price Model
2000Co-Authors: Javier Andrés, J. D. Lopez-salido, Javier VallésAbstract:The Liquidity Effect, defined as a decrease in nominal interest rates in response to a monetary expansion, is a major stylized fact of the business cycle. This paper seeks to understand under what conditions such an Effect can be explained in a general equilibrium model with sticky prices and capital adjustment costs. The paper first confirms that, with separable preferences, a low degree of intertemporal substitution in consumption is a necessary condition for the existence of the Liquidity Effect. Contrary to this result, in a model with non-separable preferences and capital accumulation it takes an implausibly high degree of intertemporal substitution to produce a Liquidity Effect. The robustness of these results to alternative degrees of nominal rigidities, money demand properties and real rigidities is also analyzed.
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The Liquidity Effect in a Small Open Economy Model
1999Co-Authors: Javier Andrés, J. D. Lopez-salido, Javier VallésAbstract:In this paper we construct a dynamic stochastic general equilibrium model for a small open economy allowing for perfect capital mobility. The model incorporates price rigidities in monopolistically competitive goods and labor markets and real rigidities in the form of capital adjustment costs. The model matches some nominal and real business cycle features observed in European economies and produces a significant output response to monetary policy shocks.
Noor Azlan Ghazali - One of the best experts on this subject based on the ideXlab platform.
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Has the Effect of money shocks on interest rates really vanished? Further evidence of the Liquidity Effect
Applied Economics, 1999Co-Authors: Benjamin J.c. Kim, Noor Azlan GhazaliAbstract:The Liquidity Effect of money shocks on the short-term interest rate has been an integral part of traditional macroeconomic policies and has witnessed renewed interest in recent years. The paper reports, contrary to some previous work, extensive evidence of the Effect in several non-G7 countries using the single-equation distributed-lag GARCH(p,q) estimation and the systems VAR estimation. The Liquidity Effect is shown to be alive and well in a sample of nine countries and this will shed much light on policy implications.
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The Liquidity Effect of money shocks on short-term interest rates: Some international evidence
International Economic Journal, 1998Co-Authors: Benjamin J.c. Kim, Noor Azlan GhazaliAbstract:There has recently been resurgence of interest in the Liquidity Effect of money shocks on short-term interest rates. This paper empirically investigates the Liquidity Effect for some of the G-7 countries, using single equation and vector autoregressive systems estimation methods. Generalized autoregressive conditional heteroskedasticity (GARCH) is employed to better capture the behaviour of interest rates and money. Our results strongly indicate presence of the Liquidity Effect in most of the countries. [E40, E52]
Marti G. Subrahmanyam - One of the best experts on this subject based on the ideXlab platform.
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Liquidity Effect in OTC options markets: Premium or discount?
Journal of Financial Markets, 2011Co-Authors: Prachi Deuskar, Anurag Gupta, Marti G. SubrahmanyamAbstract:Can the Liquidity premium in asset prices, as documented in the exchange-traded equity and bond markets, be generalized to the over-the-counter (OTC) derivative markets? Using OTC euro ([euro]) interest rate cap and floor data, we find that illiquid options trade at higher prices relative to liquid options. This Liquidity discount, though opposite to that found in equities and bonds, is consistent with the structure of this OTC market and the nature of its demand and supply forces. The results suggest that the Effect of Liquidity on asset prices cannot be generalized without regard to the characteristics of the market.