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Investigating M3 Money Demand in the Euro Area: New Evidence Based on Standard Models

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  • Christian Dreger
  • Jürgen Wolters

Abstract

Monetary growth in the euro area has exceeded its target level especially since 2001. Likewise, recent empirical studies did not find evidence in favour of a stable long run relationship between the variables entering the money demand function. Instead the equation appears to be increasingly unstable if more recent data are included. Since the link between money balances and macroeconomic variables seems to has become rather fragile, these results put serious doubts concerning the rationale of monetary aggregates in the monetary policy strategy of the ECB. However, if the analysis is done without imposing a short run homogeneity restriction between money and prices, a stable long run money demand relationship can be identified, where recursively estimated parameters are almost stable. In addition, the corresponding error correction model survives a wide array of specification tests, including procedures for nonlinearities and parameter instability. Hence, the apparent monetary overhang is in line with standard models of money demand behaviour, and is not expected to lead to a rise in inflation.

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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 561.

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Length: 48 p.
Date of creation: 2006
Date of revision:
Publication status: Published in: Journal of International Money and Finance 29 (2010) Iss.1, 111-122
Handle: RePEc:diw:diwwpp:dp561

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Keywords: Cointegration analysis; Error correction; Money demand; Monetary policy;

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References

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Citations

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Cited by:
  1. Christian Dreger & Jürgen Wolters, 2010. "M3 money demand and excess liquidity in the euro area," Public Choice, Springer, vol. 144(3), pages 459-472, September.
  2. Salvatore Capasso & Oreste Napolitano, 2012. "Testing for the stability of money demand in Italy: has the Euro influenced the monetary transmission mechanism?," Applied Economics, Taylor and Francis Journals, vol. 44(24), pages 3121-3133, August.
  3. Mierzejewski, Fernando, 2006. "Liquidity preference as rational behaviour under uncertainty," MPRA Paper 2771, University Library of Munich, Germany.
  4. Christian Dreger & Jürgen Wolters, 2008. "Money Velocity and Asset Prices in the Euro Area," Discussion Papers of DIW Berlin 813, DIW Berlin, German Institute for Economic Research.
  5. Boriss Siliverstovs, 2008. "Dynamic modelling of the demand for money in Latvia," Baltic Journal of Economics, Baltic International Centre for Economic Policy Studies, vol. 8(1), pages 53-74, October.
  6. Roberto A. De Santis & Carlo A. Favero & Barbara Roffia, 2012. "Euro Area Money Demand and International Portfolio Allocation: A Contribution to Assessing Risks to Price Stability," Working Papers 432, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  7. Mierzejewski, Fernando, 2007. "An actuarial approach to short-run monetary equilibrium," MPRA Paper 2424, University Library of Munich, Germany.
  8. Kai Carstensen & Jan Hagen & Oliver Hossfeld & Abelardo Salazar Neaves, 2008. "Money Demand Stability and Inflation Prediction in the Four Largest EMU Countries," Ifo Working Paper Series Ifo Working Paper No. 61, Ifo Institute for Economic Research at the University of Munich.
  9. Ralph Setzer & Guntram B. Wolff, 2009. "Money demand in the euro area: new insights from disaggregated data," European Economy - Economic Papers 373, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
  10. Nuno Alves & Carlos Robalo Marques & João Sousa, 2007. "Is the euro area M3 abandoning us?," Working Papers w200720, Banco de Portugal, Economics and Research Department.
  11. Arnold, Ivo J.M. & Roelands, Sebastian, 2010. "The demand for euros," Journal of Macroeconomics, Elsevier, vol. 32(2), pages 674-684, June.

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