The Daily Liquidity Effect

Abstract

Motivated, on the one hand, by the belief that the Fed controls the shortterm rate through open market operations, and on the other, by "the lack of convincing proof that this is what happens," Hamilton (1997) suggested that more convincing evidence of the liquidity effect could be obtained with the use of high-frequency (daily) data.Thornton's (2001a) detailed analysis of Hamilton's results and evidence using both Hamilton's and an alternative methodology indicates a quantitatively unimportant daily liquidity effect.Recently, Carpenter and Demiralp (2006) report "clear evidence" of a daily liquidity effect using a more comprehensive reservesupply-shock measure than that used by Hamilton.This paper investigates the daily liquidity effect using Carpenter and Demiralp's new measure.

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