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International Finance Discussion Papers
The International Finance Discussion Papers logo links to the International Finance Discussion Papers home page In Search of the Liquidity Effect
Eric M. Leeper and David B. Gordon
1991-403  (July 1991)

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.

Full paper(1190 KB PDF)

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