The liquidity effect for open market operations

Seth Kopchak

Journal of Banking & Finance, 2011, vol. 35, issue 12, 3292-3299

Abstract: The liquidity effect is the negative relationship between the supply of federal funds and the overnight federal funds rate. Deviations of the federal funds rate from its target can be interpreted as demand innovations for federal funds. Permanent adjustments to demand are modeled as an unobserved component and estimated using the Kalman filter to identify liquidity effects. The demand-based approach for identifying the liquidity effect contrasts previous work which concentrates on errors forecasting the supply of federal funds. This paper finds a liquidity effect several times larger than that from previous studies, indicating the market for federal funds is less liquid than previously thought. The effect of a $1 billion increase in open market operations over a 1-week period is a decrease of the federal funds rate by about 12 basis points.

Keywords: Liquidity effect; Open market operations; Federal funds rate (search for similar items in EconPapers)
JEL-codes: E43 E5 E58 (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (8)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:35:y:2011:i:12:p:3292-3299

DOI: 10.1016/j.jbankfin.2011.05.011

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