HOW FINANCIAL-MARKETS PROCESS MONEY INFORMATION - A REEXAMINATION OF EVIDENCE USING BAND SPECTRUM REGRESSION

This article re-examines the response of financial markets to money su pply announcements. It is argued that the previous research in the are a may be suffering from an estimation bias. The potential for estimati on bias stems from the questionable practice of assuming the same mode l for all frequency bands. A decomposition of the data into low-freque ncy and high-frequency components raises the possibility that both exp ected liquidity and expected. inflation effects are in operation simul taneously though they affect different expectation horizons. The resul ts also show that the distinct weight of these separate effects depend s essentially on the credibility of the Fed in adhering to announced m onetary targets and the state of inflationary fears.