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Expected Money Growth, Markov Trends and the Instability of Money Demand in the Euro Area

  • Sylvia Kaufmann

    ()

  • Peter Kugler

    ()

    (University of Basel)

This paper analyzes the recently documented instability of money demand in the euro area in the framework of a Markov switching trend model. First, we consider a standard °exible price model with stable money demand, rational expectations, and an exogenous income-money ratio which follows a Markov trend. This framework, which implies an in°uence of expected future money on prices, leads to a cointe- grating relationship between (log) prices and the (log of the) money-income ratio with a switching intercept term. Of course, this likely leads to a rejection of coin- tegration by standard tests and to the erroneous conclusion of an unstable money demand. Second, a more general model allowing for endogeneity and more general dynamics is estimated with Bayesian methods for euro area data from 1975-2003. This exercise provides support for our model and a stable demand for M3 in the euro area.

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Paper provided by Faculty of Business and Economics - University of Basel in its series Working papers with number 2005/07.

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Date of creation: 2005
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Handle: RePEc:bsl:wpaper:2005/07
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  1. Sylvia Kaufmann & Peter Kugler, 2005. "Does Money Matter for Inflation in the Euro Area?," Working papers 2005/09, Faculty of Business and Economics - University of Basel.
  2. Albert, James H & Chib, Siddhartha, 1993. "Bayes Inference via Gibbs Sampling of Autoregressive Time Series Subject to Markov Mean and Variance Shifts," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(1), pages 1-15, January.
  3. Kleibergen, Frank & Paap, Richard, 2006. "Generalized reduced rank tests using the singular value decomposition," Journal of Econometrics, Elsevier, vol. 133(1), pages 97-126, July.
  4. Kleibergen, Frank & Paap, Richard, 2002. "Priors, posteriors and bayes factors for a Bayesian analysis of cointegration," Journal of Econometrics, Elsevier, vol. 111(2), pages 223-249, December.
  5. Hall, Stephen G & Psaradakis, Zacharias & Sola, Martin, 1997. "Cointegration and Changes in Regime: The Japanese Consumption Function," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 12(2), pages 151-68, March-Apr.
  6. Kugler, Peter, 1996. "The term structure of interest rates and regime shifts: Some empirical results," Economics Letters, Elsevier, vol. 50(1), pages 121-126, January.
  7. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
  8. Kai Carstensen, 2003. "Is European Money Demand Still Stable?," Kiel Working Papers 1179, Kiel Institute for the World Economy.
  9. Paap, R. & van Dijk, H.K., 2002. "Bayes estimates of Markov trends in possibly cointegrated series: an application to US consumption and income," Econometric Institute Research Papers EI 2002-42, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
  10. Warne, Anders & Bruggeman, Annick & Donati, Paola, 2003. "Is the demand for euro area M3 stable?," Working Paper Series 0255, European Central Bank.
  11. Hamilton, James D., 1988. "Rational-expectations econometric analysis of changes in regime : An investigation of the term structure of interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 385-423.
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