THE LIQUIDITY EFFECT - IDENTIFYING SHORT-RUN INTEREST-RATE DYNAMICS USING LONG-RUN RESTRICTIONS

This paper identifies money supply shocks using long-run money neutral ity restrictions within a vector autoregression framework to estimate the dynamic response of interest rates to such shocks-the liquidity ef fect. This identification procedure has several advantages over proced ures used in previous studies, including the fact that it is consisten t with a larger class of theoretical models. Using this approach on a sample of monthly macroeconomic data, we find evidence for a liquidity effect. This finding is robust across alternative measures of the mon ey stock.