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The functional form of the demand for euro area M1

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  • Stracca, Livio

Abstract

A remarkable development seen in recent years is the pronounced decline in euro area M1 velocity vis--vis a moderate decline in short-term interest rates, which represent the most natural opportunity cost for M1, suggesting an increase in the interest rate elasticity of M1 demand. In fact, estimating a theoretically plausible and stable demand function for M1 in the euro area is possible, if a functional form of money demand allowing for an interest rate elasticity decreasing in size with the level of the interest rate is imposed. This finding would apparently suggest that the decline in inflation and nominal interest rates in Europe experienced in the run-up to the euro should have 'naturally' brought about an increased degree of preference for liquidity without any fundamental change in agents' preferences. To test the validity of this conclusion, a time-varying parameters model is estimated through Kalman filter on the level of real M1, which is able to test simultaneously the stability of the parameters and the functional form of the demand for euro area M1. In this case, results clearly suggest the double log function to be very close to the true 'deep' functional form of M1 demand in the euro area, consistent with the findings of Chadha, Haldane and Janssen (1998) for the United Kingdom and of Lucas (2000) for the United States. At the same time, there is evidence of an increased interest rate elasticity in M1 demand in the most recent years, presumably associated with the transition to the new environment prevailing from the start of Stage Three of EMU JEL Classification: E41, E52

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Paper provided by European Central Bank in its series Working Paper Series with number 0051.

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Date of creation: Mar 2001
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Handle: RePEc:ecb:ecbwps:20010051

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  1. Davis, E. Philip & De Bandt, Olivier, 1999. "A cross-country comparison of market structures in European banking," Working Paper Series 0007, European Central Bank.
  2. Detken, Carsten & Hartmann, Philipp, 2000. "The Euro and International Capital Markets," CEPR Discussion Papers 2461, C.E.P.R. Discussion Papers.
  3. Monticello, Carlo & Tristani, Oreste, 1999. "What does the single monetary policy do? A SVAR benchmark for the European Central Bank," Working Paper Series 0002, European Central Bank.
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Cited by:
  1. Rodriguez-Palenzuela, Diego & Camba-Méndez, Gonzalo & García, Juan Angel, 2003. "Relevant economic issues concerning the optimal rate of inflation," Working Paper Series 0278, European Central Bank.
  2. Reimers, Hans-Eggert, 2002. "Analysing Divisia Aggregates for the Euro Area," Discussion Paper Series 1: Economic Studies 2002,13, Deutsche Bundesbank, Research Centre.
  3. Hans-Eggert Reimers, 2003. "Does Money Include Information for Prices in the Euro Area?," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), Justus-Liebig University Giessen, Department of Statistics and Economics, vol. 223(5), pages 581-602, September.
  4. Dumitru, Ionut, 2002. "Money Demand in Romania," MPRA Paper 10629, University Library of Munich, Germany.
  5. Calza, Alessandro & Zaghini, Andrea, 2006. "Non-linear dynamics in the euro area demand for M1," Working Paper Series 0592, European Central Bank.
  6. Stracca, Livio, 2001. "Does liquidity matter? Properties of a synthetic divisia monetary aggregate in the euro area," Working Paper Series 0079, European Central Bank.
  7. Calza, Alessandro & Zaghini, Andrea, 2009. "Nonlinearities In The Dynamics Of The Euro Area Demand For M1," Macroeconomic Dynamics, Cambridge University Press, vol. 13(01), pages 1-19, February.
  8. Jarko Fidrmuc, 2009. "Money demand and disinflation in selected CEECs during the accession to the EU," Applied Economics, Taylor & Francis Journals, vol. 41(10), pages 1259-1267.
  9. Ingrid Groessl & Ulrich Fritsche, 2006. "The Store-of-Value-Function of Money as a Component of Household Risk Management," Macroeconomics and Finance Series 200606, Hamburg University, Department Wirtschaft und Politik.
  10. Gilbert KOENIG, 2004. "La demande de billets de valeurs faciales élevées et les activités financières souterraines," Discussion Papers (REL - Recherches Economiques de Louvain) 2004042, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  11. Sanvi Avouyi-Dovi & Françoise Drumetz & Jean-Guillaume Sahuc, 2007. "The money demand function for the Euro area: one step beyond," Documents de recherche 07-08, Centre d'Études des Politiques Économiques (EPEE), Université d'Evry Val d'Essonne.
  12. Avouyi-Dovi, S. & Diop, A. & Fonteny, E-C. & Gervais, E. & Jacquinot, P. & Mésonnier, J-S. & Sahuc, J-G., 2003. "Estimation d’une fonction de demande de monnaie pour la zone euro : une synthèse des résultats," Bulletin de la Banque de France, Banque de France, issue 111, pages 47-72.
  13. Nautz, Dieter & Offermanns, Christian J., 2006. "Does the Euro follow the German Mark? Evidence from the monetary model of the exchange rate," European Economic Review, Elsevier, vol. 50(5), pages 1279-1295, July.
  14. Klaus Masuch & Sergio Nicoletti-Altimari & Massimo Rostagno & Huw Pill, 2003. "The role of money in monetary policymaking," BIS Papers chapters, in: Bank for International Settlements (ed.), Monetary policy in a changing environment, volume 19, pages 158-191 Bank for International Settlements.
  15. Seitz, Franz & von Landesberger, Julian, 2010. "Household money holdings in the euro area: An explorative investigation," Working Paper Series 1238, European Central Bank.

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