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Money and Inflation in the Euro Area during the Financial Crisis

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  • Christian Dreger
  • Jürgen Wolters

Abstract

This paper explores the stability of the relation between money demand for M3 and inflation in the euro area by including the recent period of the financial crisis. Evidence is based on a cointegration analysis, where inflation and asset prices are allowed to enter the long run relationship. By restricting the cointegrating space, equations for money and inflation are identified. The results indicate that the equilibrium evolution of M3 is still in line with money demand. In the long run, inflation is affected by asset prices and detrended output. Excess liquidity plays an important role for inflation dynamics. While the hypothesis of weak exogeneity is rejected for real money balances and inflation, real income, real asset prices and the term structure do not respond to deviations from the long run equilibria. A single equation analysis derived from this system still provides reliable information for the conduct of monetary policy in real time, since the error correction terms are very similar to those obtained by the system approach. To monitor the monetary development, a single money demand equation is sufficient, at least as a rough indication.

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File URL: http://www.diw.de/documents/publikationen/73/diw_01.c.373382.de/dp1131.pdf
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Bibliographic Info

Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 1131.

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Length: 37 p.
Date of creation: 2011
Date of revision:
Handle: RePEc:diw:diwwpp:dp1131

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Keywords: Money demand; inflation; excess liquidity; cointegration analysis;

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References

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  1. Christian Dreger & J¨¹rgen Wolters, 2011. "Liquidity and Asset Prices: How Strong are the Linkages?," Review of Economics & Finance, Better Advances Press, Canada, vol. 1, pages 43-52, February.
  2. Gunter Coenen & Juan Luis Vega, 2000. "The Demand for M3 in the Euro Area," Econometric Society World Congress 2000 Contributed Papers 0976, Econometric Society.
  3. 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.
  4. Joaquim Vieira Ferreira Levy & Alessandro Calza & Dieter Gerdesmeier, 2001. "Euro Area Money Demand," IMF Working Papers 01/179, International Monetary Fund.
  5. Christian Dreger & Jürgen Wolters, 2013. "Money demand and the role of monetary indicators in forecasting euro area inflation," FIW Working Paper series 119, FIW.
  6. Christian Dreger & Jürgen Wolters, 2008. "Money Velocity and Asset Prices in the Euro Area," Working Paper / FINESS, DIW Berlin, German Institute for Economic Research 7.1b, DIW Berlin, German Institute for Economic Research.
  7. Henrik Hansen & Søren Johansen, 1999. "Some tests for parameter constancy in cointegrated VAR-models," Econometrics Journal, Royal Economic Society, vol. 2(2), pages 306-333.
  8. Adalid, Ramón & Detken, Carsten, 2007. "Liquidity shocks and asset price boom/bust cycles," Working Paper Series 0732, European Central Bank.
  9. Mike Artis & Andreas Beyer, 2004. "Issues in Money Demand: The Case of Europe," Journal of Common Market Studies, Wiley Blackwell, vol. 42(4), pages 717-736, November.
  10. repec:diw:diwfin:diwfin07012 is not listed on IDEAS
  11. Rajaguru, Gulasekaran & Abeysinghe, Tilak, 2008. "Temporal aggregation, cointegration and causality inference," Economics Letters, Elsevier, vol. 101(3), pages 223-226, December.
  12. Beyer, Andreas & Juselius, Katarina, 2010. "Does it matter how aggregates are measured? The case of monetary transmission mechanisms in the euro area," Working Paper Series 1149, European Central Bank.
  13. Berger, Helge & Harjes, Thomas & Stavrev, Emil, 2008. "The ECB's monetary analysis revisited," Discussion Papers 2008/14, Free University Berlin, School of Business & Economics.
  14. Dreger, Christian & Wolters, Jürgen, 2010. "Investigating M3 money demand in the euro area," Journal of International Money and Finance, Elsevier, vol. 29(1), pages 111-122, February.
  15. Christian Dreger & Jürgen Wolters, 2008. "M3 Money Demand and Excess Liquidity in the Euro Area," Working Paper / FINESS, DIW Berlin, German Institute for Economic Research 7.1a, DIW Berlin, German Institute for Economic Research.
  16. Greiber, Claus & Setzer, Ralph, 2007. "Money and housing: evidence for the euro area and the US," Discussion Paper Series 1: Economic Studies 2007,12, Deutsche Bundesbank, Research Centre.
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Cited by:
  1. Christian Dreger & Jürgen Wolters, 2010. "Money Demand and the Role of Monetary Indicators in Forecasting Euro Area Inflation," Discussion Papers of DIW Berlin 1064, DIW Berlin, German Institute for Economic Research.
  2. Matteo Barigozzi & Antonio Conti, 2013. "On the Stability of Euro Area Money Demand and its Implications for Monetary Policy," LEM Papers Series 2013/11, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.

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