A real business cycle model with money as a sunspot variable

•In a standard RBC model, money is neutral. This is not supported by the data.•Using money as a sunspot variable can reconcile the RBC model with the money data.•The RBC’s frictionless environment and flexible prices are retained.•My model identifies a specific sunspot variable. A well-known criticism of the RBC model is that it cannot match the data on money. Due to the perfect flexibility of prices and the absence of frictions, any exogenous increase in the money supply will be fully offset by wage and price increases, implying that money is neutral even in the short run. However, beliefs that money is non-neutral could become a self-fulfilling prophesy. By using money as a sunspot variable in an RBC model, I successfully replicate many of the correlations in the data, even though money does not directly affect the economy’s fundamentals. This shows that models with flexible prices are not necessarily incompatible with the monetary data and offers support for the use of sunspot variables in macroeconomics.