THE IDENTIFICATION OF MONETARY-POLICY DISTURBANCES - EXPLAINING THE LIQUIDITY PUZZLE

This paper examines recent work on the identification of monetary policy disturbances. Its main finding is that the empirical anomalies found in the literature reflect a failure to properly address the Federal Reserve's policy of accommodating reserve demand shocks. A new method of identifying monetary policy using nonborrowed reserves is proposed. Using this specification - policy has a strong persistent liquidity effect regardless of subsample - policy Granger-causes output even in the presence of interest rates, explaining approximately 49% of the variance in output at a two-year horizon - and the residual explanatory power of interest rates for output is negligible.