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M3 Money Demand and Excess Liquidity in the Euro Area

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Author Info
Christian Dreger
Jürgen Wolters

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Abstract

Money growth in the euro area has exceeded its target since 2001. Likewise, recent empirical studies did not find evidence in favour of a stable long run money demand function. The equation appears to be increasingly unstable if more recent data are used. If the link between money balances and the macroeconomy is fragile, the rationale of monetary aggregates in the ECB strategy has to be doubted. In contrast to the bulk of the literature, we are able to identify a stable long run money demand relationship for M3 with reasonable long run behaviour. This finding is robust for different (ML and S2S) estimation methods. To obtain the result, the short run homogeneity restriction between money and prices is relaxed. In addition, a rise in the income elasticity after 2001 is taken into account. The break might be linked to the introduction of euro coins and banknotes. The monetary overhang and the real money gap do not indicate significant inflation pressures. The corresponding error correction model survives a battery of specification tests.

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File URL: http://www.diw.de/documents/publikationen/73/diw_01.c.96127.de/diw_finess_07011.pdf
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Paper provided by DIW Berlin, German Institute for Economic Research in its series Working Paper / FINESS with number 7.1a.

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Length: 28 p.
Date of creation: 2008
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Handle: RePEc:diw:diwfin:diwfin07011

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Related research
Keywords: Cointegration analysis; error correction; excess liquidity; money demand; monetary policy;

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Find related papers by JEL classification:
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions
C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation and Testing
E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money

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  1. MacKinnon, James G & Haug, Alfred A & Michelis, Leo, 1999. "Numerical Distribution Functions of Likelihood Ratio Tests for Cointegration," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 14(5), pages 563-77, Sept.-Oct. [Downloadable!]
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  2. G. Coenen & J.-L. Vega, 2001. "The demand for M3 in the euro area," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 16(6), pages 727-748. [Downloadable!]
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  3. Gabriel Fagan & JÊrÆme Henry, 1998. "Long run money demand in the EU: Evidence for area-wide aggregates," Empirical Economics, Springer, vol. 23(3), pages 483-506. [Downloadable!] (restricted)
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  5. Helmut Lütkepohl & Ralf Brüggemann, 2006. "A small monetary system for the euro area based on German data," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(6), pages 683-702. [Downloadable!]
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  6. Claus Brand & Nuno Cassola, 2004. "A money demand system for euro area M3," Applied Economics, Taylor and Francis Journals, vol. 36(8), pages 817-838, May. [Downloadable!] (restricted)
  7. Gerlach, Stefan & Svensson, Lars E. O., 2003. "Money and inflation in the euro area: A case for monetary indicators?," Journal of Monetary Economics, Elsevier, vol. 50(8), pages 1649-1672, November. [Downloadable!] (restricted)
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  8. Jürgen Wolters & Timo Teräsvirta & Helmut Lütkepohl, 1998. "Modeling The Demand For M3 In The Unified Germany," The Review of Economics and Statistics, MIT Press, vol. 80(3), pages 399-409, August. [Downloadable!] (restricted)
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  9. Christian Dreger & Jürgen Wolters, 2006. "Investigating M3 Money Demand in the Euro Area: New Evidence Based on Standard Models," Discussion Papers of DIW Berlin 561, DIW Berlin, German Institute for Economic Research. [Downloadable!]
  10. Roberto Golinelli & Sergio Pastorello, 2002. "Modelling the demand for M3 in the Euro area," European Journal of Finance, Taylor and Francis Journals, vol. 8(4), pages 371-401, December. [Downloadable!] (restricted)
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  13. Bosker, E.M., 2006. "On the aggregation of eurozone data," Economics Letters, Elsevier, vol. 90(2), pages 260-265, February. [Downloadable!] (restricted)
  14. Hallman, Jeffrey J & Porter, Richard D & Small, David H, 1991. "Is the Price Level Tied to the M2 Monetary Aggregate in the Long Run?," American Economic Review, American Economic Association, vol. 81(4), pages 841-58, September. [Downloadable!] (restricted)
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  16. Hwang, Hae-shin, 1985. "Test of the Adjustment Process and Linear Homogeneity in a Stock Adjustment Model of Money Demand," The Review of Economics and Statistics, MIT Press, vol. 67(4), pages 689-92, November. [Downloadable!] (restricted)
  17. Stefan Gerlach, 2004. "The two pillars of the European Central Bank," Economic Policy, CEPR, CES, MSH, vol. 19(40), pages 389-439, October. [Downloadable!] (restricted)
  18. Ralf Brüggemann & Helmut Lütkepohl, 2005. "Practical Problems with Reduced-rank ML Estimators for Cointegration Parameters and a Simple Alternative," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 67(5), pages 673-690, October. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Christian Dreger & Jürgen Wolters, 2008. "Money Velocity and Asset Prices in the Euro Area," Working Paper / FINESS 7.1b, DIW Berlin, German Institute for Economic Research. [Downloadable!]
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