Most current empirical work finds no evidence that money shocks lower interest rates. The authors show that these nonresults are mainly due to a failure to model the conditional heteroskedasticity of interest rates. Autoregressive conditional heteroskedasiticity (ARCH) models find a significant liquidity effect where ordinary least squares (OLS) models do not. The existence of a liquidity effect is found using different models and sample periods when ARCH models are used in estimation but never when OLS is employed.

ABSTRACT Most current empirical work finds no evidence that money shocks lower interest rates. We show that these nonresults are mainly due to a failure to model the conditional heteroskedasticity of interest rates. Autoregressive conditional heteroskedasticity (ARCH) models find a significant liquidity effect where ordinary least squares (OLS) models do not. The existence of a liquidity effect is found using different models and sample periods when ARCH models are used in estimation, but never when OLS is employed.