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Quantity theory is alive: the role of international portfolio shifts

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  • De Santis, Roberto A.
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    Abstract

    We challenge the view that the relationship between money and prices is too loose in countries with low inflation rates and argue that cross-border portfolio shifts are the root cause of the volatility in real money balances. The novelty of this paper is that we model jointly in the euro area and the United States (i) the equilibrium in the money market that takes into account the cross-border portfolio shifts, and (ii) the equilibrium in the domestic asset markets, by finding a no-arbitrage relation between domestic long-horizon expected stock and bond returns. We estimate a stable money demand in the long-run and find that the short-run correlation between annual inflation and model-based excess money growth is not statistically different from unity in both the euro area and the United States. We also find that the resulting long-run equity risk premium comoves counter-cyclically with quarterly real GDP growth in both economies. JEL Classification: E31, E41, E51, E52, G58, F40

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    Bibliographic Info

    Paper provided by European Central Bank in its series Working Paper Series with number 1435.

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    Date of creation: May 2012
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    Handle: RePEc:ecb:ecbwps:20121435

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    Keywords: asset prices; Money demand;

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    13. Thomas J. Sargent & Paolo Surico, 2011. "Two Illustrations of the Quantity Theory of Money: Breakdowns and Revivals," American Economic Review, American Economic Association, vol. 101(1), pages 109-28, February.
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    Cited by:
    1. Gianni Amisano & Roberta Colavecchio, 2013. "Money Growth and Inflation: evidence from a Markov Switching Bayesian VAR," Macroeconomics and Finance Series 201304, Hamburg University, Department Wirtschaft und Politik.

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