Monetary Policy Shocks and Cholesky-VARs: An Assessment for the Euro Area

An estimated monetary policy VAR with 1993:IV-2008:III Euro data returns an insignificant response of inflation and a borderline significant reaction of the output gap to monetary policy shocks identified with the widely-employed Cholesky restrictions. We replicate this evidence with a Monte Carlo exercise in which the true responses of inflation and the output gap, according to an estimated DSGE model which we use as Data-Generating Process, are negative. Consequently, insignificant macroeconomic reactions to policy shocks as documented by a small-scale Cholesky-VAR for the Euro area do not necessarily point to monetary policy neutrality. Di¤erently, the Cholesky-VAR evidence may very well be due to false short-run zero-restrictions. A data-driven discussion on this reading of the drivers of our Cholesky-VAR impulse responses vs. alternative interpretations such as omitted factors and structural breaks is proposed.