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On the Stability of Euro Area Money Demand and its Implications for Monetary Policy

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  • Matteo Barigozzi
  • Antonio Conti

Abstract

We revisit the usefulness of long-run money demand equations for the European Central Bank. We first conduct a model evaluation exercise by means of a recent timeóvarying cointegration test. A stable relation for euro area M3 is not rejected by data only when accounting for both a speculative motive, represented by international financial markets, and a precautionary motive, proxied by changes in the unemployment rate. Second, relying on this finding, we propose and estimate a novel time-invariant specification for money demand which allows us (i) to build a leading indicator of stock market busts and (ii) to describe the anomalous behavior of M3 in the last decade. Excess liquidity matters for both financial and price stability.

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Bibliographic Info

Paper provided by Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy in its series LEM Papers Series with number 2013/11.

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Date of creation: 23 Apr 2013
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Handle: RePEc:ssa:lemwps:2013/11

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Keywords: money demand; time-varying cointegration; priceóearnings ratios; unemployment rate; monetary policy;

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