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A Portofolio Balance Approach to Euro-Area Money Demand in a Time-Varying Environment

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Author Info

  • Stephen G.Hall

    (Leicester University and NIESR)

  • George Hondroyiannis

    (Bank of Greece)

  • P.A.V.B. Swamy

    (U.S. Bureau of Labor Statistics)

  • George S. Tavlas

    ()
    (Bank of Greece a)

Abstract

As part of its monetary policy strategy, the European Central Bank has formulated a reference value for M3 growth. A pre-requisite for the use of a reference value for M3 growth is the existence of a stable demand function for that aggregate. However, a large empirical literature has emerged showing that, beginning in 2001, essentially all euro area M3 demand functions have exhibited instability. This paper considers euroarea money demand in the context of the portfolio-balance framework. Our basic premise is that there is a stable demand-for-money function but that the models that have been used until now to estimate euro area money-demand are not well-specified because they do not include a measure of wealth. Using two empirical methodologies - - a co-integrated vector equilibrium correction (VEC) approach and a time-varying coefficient (TVC) approach - - we find that a demand-for-money function that includes wealth is stable. The upshot of our findings is that M3 behaviour continues to provide useful information about medium-term developments on inflation.

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Bibliographic Info

Paper provided by Bank of Greece in its series Working Papers with number 61.

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Length: 36 pages
Date of creation: Oct 2007
Date of revision:
Handle: RePEc:bog:wpaper:61

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Web page: http://www.bankofgreece.gr
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Keywords: Money demand; VEC; time varying coefficient estimation; Euro area;

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References

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  1. Zellner, Arnold, 2007. "Philosophy and objectives of econometrics," Journal of Econometrics, Elsevier, vol. 136(2), pages 331-339, February.
  2. Davidson, James & Hall, Stephen, 1991. "Cointegration in Recursive Systems," Economic Journal, Royal Economic Society, vol. 101(405), pages 239-51, March.
  3. Swamy, P A V B & Tavlas, George S, 1995. " Random Coefficient Models: Theory and Applications," Journal of Economic Surveys, Wiley Blackwell, vol. 9(2), pages 165-96, June.
  4. Johansen, Soren, 1995. "Identifying restrictions of linear equations with applications to simultaneous equations and cointegration," Journal of Econometrics, Elsevier, vol. 69(1), pages 111-132, September.
  5. M Pesaran & Yongcheol Shin, 2004. "Long-Run Structural Modelling," ESE Discussion Papers 44, Edinburgh School of Economics, University of Edinburgh.
  6. David Cobham, 1996. "Causes and Effects of the European Monetary Crises of 1992-93," Journal of Common Market Studies, Wiley Blackwell, vol. 34(4), pages 585-604, December.
  7. George S. Tavlas & P.A.V.B. Swamy, 2006. "The New Keynesian Phillips Curve and Inflation Expectations: Re-Specification and Interpretation," Working Papers 34, Bank of Greece.
  8. Pratt, John W. & Schlaifer, Robert, 1988. "On the interpretation and observation of laws," Journal of Econometrics, Elsevier, vol. 39(1-2), pages 23-52.
  9. P. Swamy & George Tavlas, 2005. "Theoretical conditions under which monetary policies are effective and practical obstacles to their verification," Economic Theory, Springer, vol. 25(4), pages 999-1005, 06.
  10. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February.
  11. Granger, C. W. J. & Newbold, P., 1974. "Spurious regressions in econometrics," Journal of Econometrics, Elsevier, vol. 2(2), pages 111-120, July.
  12. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
  13. Friedman, Milton & Schwartz, Anna J, 1991. "Alternative Approaches to Analyzing Economic Data," American Economic Review, American Economic Association, vol. 81(1), pages 39-49, March.
  14. Joaquim Vieira Ferreira Levy & Alessandro Calza & Dieter Gerdesmeier, 2001. "Euro Area Money Demand," IMF Working Papers 01/179, International Monetary Fund.
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Cited by:
  1. Ansgar Belke & Robert Czudaj, 2010. "Is Euro Area Money Demand (Still) Stable? – Cointegrated VAR versus Single Equation Techniques," Ruhr Economic Papers 0171, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
  2. Stephen Hall & Amangeldi Kenjegaliev & P.A.V.B. Swamy & George S. Tavlas, 2013. "Measuring Currency Pressures: The Cases of the Japanese Yen, the Chinese Yuan, and the U.K. Pound," Discussion Papers in Economics 13/10, Department of Economics, University of Leicester.
  3. Stephan Barisitz, 2008. "Banking Transformation (1989 - 2006) in Central and Eastern Europe - With Special Reference to Balkans," Working Papers 78, Bank of Greece.
  4. Fredj Jawadi & Ricardo M. Sousa, 2012. "Money Demand in the euro area, the US and the UK:Assessing the Role of Nonlinearity," NIPE Working Papers 22/2012, NIPE - Universidade do Minho.
  5. Stephen G. Hall & P.A.V.B. Swamy & George S. Tavlas, 2012. "Milton Friedman, the demand for money, and the ECB’s monetary policy strategy," Review, Federal Reserve Bank of St. Louis, issue May, pages 153-186.
  6. Peter Bernholz, 2008. "Government Bankruptcy of Balkan Nations and their Consequences for Money and Inflation before 1914: A Comparative Analysis," Working Papers 74, Bank of Greece.
  7. Sophia Lazaretou, 2009. "Money supply and Greek history monetary statistics: definition, construction, sources and data," Working Papers 105, Bank of Greece.

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