The liquidity effect of money on short term interest rates: The New Zealand experience

Abstract

The paper examines evidence for the liquidity effect of money on short term interest rates: the initial fall (rise) in the ex ante nominal and (real) interest rates, due to an initial increase (decrease) in liquidity. One hypothesis that is examined is whether financial deregulation has changed the money‐interest rate relationship in New Zealand. It was found that the liquidity affect was absent during the period of financial market controls prior to 1985. However, since then, there is some evidence of a liquidity effect for all monetary and credit aggregates used. In the post deregulation period, the strongest results were obtained when the chosen credit variable was the Volume of Discounting at the Reserve Bank window. Unlike other monetary indicators, this variable was also found to be strictly Granger exogenous with respect to interest rates.

Notes

Department of Economics, University of Auckland.