Is there a liquidity effect? An investigation using the Kalman filter

We test for a liquidity effect by utilizing a Kalman filter and find that monetary innovations lowered interest rates in 51 out of the 120 quarters in our sample. This implies that the recent empirical consensus of no liquidity effect has resulted from the implicit assumption that monetary innovations always impact interest rates in the same direction, rather than from an absence of a liquidity effect in the data (JEL E4).