The liquidity effect and the operating procedure of the federal reserve

This paper reports evidence that the relation between interest rates and mo ney shocks depends on the Federal Reserve's operating procedure. A signific ant liquidity effect is detected only when a nonborrowed reserve measure is used to identify policy shocks. When broad monetary aggregates are conside red, a liquidity effect is not observed. However, where a liquidity effect is documented, it is primarily due to the 1979-1982 period in which a nonbo rrowed reserve operating procedure was adopted. If this period is omitted, then interest rates and money shocks are largely independent regardless of which monetary aggregate is used to measure policy shocks.