THE VANISHING LIQUIDITY EFFECT OF MONEY ON INTEREST: ANALYSIS AND IMPLICATIONS FOR POLICY

Authors

  • MICHAEL MELVIN

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    • *Arizona State University. Thanks are due John Chant, Herb Kaufman, and two anonymous referees for commenting on an earlier draft of this paper.


Abstract

This paper seeks to re-examine the effects of money on interest rates. The earlier literature on this topic determined, fairly well, the pattern of response of interest rates to changes in money growth. The notable studies of Cagan (1972), Cagan and Gandolfi (1969), and Gibson (1970) served to establish the professions “stylized pattern” as presented in section I. Section II presents new evidence on the subject and finds that the old empirical generalizations no longer hold. Specifically, the results suggest that the initial liquidity effect of faster money growth is likely to be offset within the month following the monetary policy change. Sections III and IV investigate the reasons for the changing pattern of monetary effects on interest rates and discuss the policy implications of the new pattern.

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