A Two-Pillar DSGE Monetary Policy Model for the Euro Area

Whereas the bulk of the literature on DSGE models provides a rationale for in‡ation targeting strategies, there is no model doing such a job for the strategy implemented for almost ten years now by the Eurosystem and known as the "two-pillar monetary policy strategy". We try to address this issue by developping a small "two-pillar" DSGE model for the euro area. In this paper: 1) we allow real balances to appear both in the IS and Phillips curves; 2) we …nd some evidence that money plays a non-trivial role in explaining the euro area business cycle; 3) this provides a rationale for the central bank (the European Central Bank) to factor in monetary developments, by exploiting the long-run relationship between money growth and in‡ation, eventually accounting for structural shifts in velocity; 4) we found some evidence that the ECB has reacted systematically to a …ltered measure of money growth but not necessarily in a non-linear way, i.e. by di¤erentiating high money growth periods ("excess liquidity") from "normal" ones. JEL classi…cation: E52; E58;