The Liquidity Effects: Evidence from Regulated Financial Markets

The liquidity eflect is a key to explaining monetary transmission mechanism in both traditional and recent theoretical monetary models. The empirical support for the liquidity eflect, however, is not strong enough to corroborate its signiï¬ cance in the actual economy. Since interest rates have been regulated strictly in the Korean ï¬ nancial markets, one can conjecture that interest rates would not be responsive to monetary shocks. This paper investigates whether the liquidity eflect can be found in the Korean economy. The money supply shocks can be identified easily because the Korean central bank has adopted monetary targeting until recently. A VAR model is used to examine whether the short-run interest rate declines in response to expansive monetary shocks. The main ï¬ nding is that the liquidity eflect can be found only aï¬ er the deregulation in the ï¬ nancial markets in the early 1980s.