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Nonlinearities in the dynamics of the euro area demand for M1

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  • Alessandro Calza

    ()
    (European Central Bank)

  • Andrea Zaghini

    ()
    (Bank of Italy, Economics, Research and International Relations Area)

Abstract

The paper finds evidence of non-linearities in the dynamics of the euro-area demand for the narrow aggregate M1. A long-run money demand relationship is first estimated over a sample period covering the last three decades. While the parameters of the relationship are jointly stable, there are indications of non-linearity in the residuals of the error-correction model. This non-linearity is explicitly modelled using a fairly general Markov switching error-correction model with satisfactory results. The empirical findings of the paper are consistent with theoretical predictions of non-linearities in the dynamics of adjustment to equilibrium stemming from "buffer stock" and "target-threshold" models and with analogous empirical evidence for European countries and the US.

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Bibliographic Info

Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 690.

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Date of creation: Sep 2008
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Handle: RePEc:bdi:wptemi:td_690_08

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Keywords: Euro area; cointegration; non-linear error-correction; demand for money;

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  1. Barnett, William A., 2007. "Multilateral aggregation-theoretic monetary aggregation over heterogeneous countries," Journal of Econometrics, Elsevier, vol. 136(2), pages 457-482, February.
  2. Gandolfi, Arthur E & Lothian, James R, 1983. "International Price Behavior and the Demand for Money," Economic Inquiry, Western Economic Association International, vol. 21(3), pages 295-311, July.
  3. Stracca, Livio, 2001. "The functional form of the demand for euro area M1," Working Paper Series 0051, European Central Bank.
  4. Bierens, Herman J., 1997. "Nonparametric cointegration analysis," Journal of Econometrics, Elsevier, vol. 77(2), pages 379-404, April.
  5. Andrew Ang & Geert Bekaert, 1998. "Regime Switches in Interest Rates," NBER Working Papers 6508, National Bureau of Economic Research, Inc.
  6. Camacho, Maximo, 2005. "Markov-switching stochastic trends and economic fluctuations," Journal of Economic Dynamics and Control, Elsevier, vol. 29(1-2), pages 135-158, January.
  7. Laidler, David, 1984. "The 'Buffer Stock' Notion in Monetary Economics," Economic Journal, Royal Economic Society, vol. 94(376a), pages 17-34, Supplemen.
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