Liquidity Matters: Money Non-Redundancy in the Euro Area Business Cycle∗

While New Keynesian models label money redundant in shaping business cycle, monetary aggregates are found relevant in predicting output, prices and interest rates or correctly identifying monetary policy shocks. This paper provides new evidence of money non redundancy in Euro area business cycle, contrary to most of recent literature. We study the dynamic effects of liquidity shocks under different traditional identifying methods, assessing their relevance compared to other sources of fluctuations. To shed some lights on money’s role we propose to adopt an agnostic approach on the effects of liquidity shocks, thus letting data answer. Results show that shocks to monetary aggregates raise output, prices and policy rate, having a permanent effect on the latter. Hence, (i) money can not be omitted in modeling economic structure; (ii) liquidity is a powerful transmission in the short run, even more effective than interest rate channel. Our findings point to a reexamination of theoretical models and seem to support the emphasis given by European Central Bank (ECB) to the monetary pillar. JEL classification E52; E58; C32.