The identification of liquidity effects in the EMS: Italy 1991-1992

We study the impact of liquidity shocks in Italy in the 1991-1992 period, when the lira belonged to the narrow ERM band with no exchange controls. We conduct our analysis by constructing (not simply assuming) predetermined measures of liquidity supply shocks, taking into account the institutional features of the money market and the reserve requirements' average computation system. We find that the supply of liquidity did significantly affect short-term interest rates; however, in contrast to earlier periods, most of the interest rate variations were attributable to foreign-exchange-related factors, as predicted by the ''asymmetric view'' of the ERM.