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Money and Inflation in the Euro Area during the Financial Crisis

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  • Christian Dreger
  • Jürgen Wolters

Abstract

This paper explores the stability of the relation between money demand for M3 and inflation in the euro area by including the recent period of the financial crisis. Evidence is based on a cointegration analysis, where inflation and asset prices are allowed to enter the long run relationship. By restricting the cointegrating space, equations for money and inflation are identified. The results indicate that the equilibrium evolution of M3 is still in line with money demand. In the long run, inflation is affected by asset prices and detrended output. Excess liquidity plays an important role for inflation dynamics. While the hypothesis of weak exogeneity is rejected for real money balances and inflation, real income, real asset prices and the term structure do not respond to deviations from the long run equilibria. A single equation analysis derived from this system still provides reliable information for the conduct of monetary policy in real time, since the error correction terms are very similar to those obtained by the system approach. To monitor the monetary development, a single money demand equation is sufficient, at least as a rough indication.

Suggested Citation

  • Christian Dreger & Jürgen Wolters, 2011. "Money and Inflation in the Euro Area during the Financial Crisis," Discussion Papers of DIW Berlin 1131, DIW Berlin, German Institute for Economic Research.
  • Handle: RePEc:diw:diwwpp:dp1131
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    References listed on IDEAS

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    1. Dreger, Christian & Wolters, Jürgen, 2010. "M3 Money Demand and Excess Liquidity in the Euro Area," EconStor Open Access Articles, ZBW - German National Library of Economics, pages 459-472.
    2. Dreger, Christian & Wolters, Jürgen, 2010. "Investigating M3 money demand in the euro area," Journal of International Money and Finance, Elsevier, vol. 29(1), pages 111-122, February.
    3. G. Coenen & J.-L. Vega, 2001. "The demand for M3 in the euro area," Journal of Applied Econometrics, John Wiley & Sons, Ltd., pages 727-748.
    4. Jürgen Wolters & Timo Teräsvirta & Helmut Lütkepohl, 1998. "Modeling The Demand For M3 In The Unified Germany," The Review of Economics and Statistics, MIT Press, pages 399-409.
    5. Christian Dreger & Jürgen Wolters, 2009. "Money velocity and asset prices in the euro area," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, pages 51-63.
    6. Henrik Hansen & Søren Johansen, 1999. "Some tests for parameter constancy in cointegrated VAR-models," Econometrics Journal, Royal Economic Society, vol. 2(2), pages 306-333.
    7. Beyer, Andreas & Juselius, Katarina, 2010. "Does it matter how aggregates are measured? The case of monetary transmission mechanisms in the euro area," Working Paper Series 1149, European Central Bank.
    8. Christian Dreger & J¨¹rgen Wolters, 2011. "Liquidity and Asset Prices: How Strong are the Linkages?," Review of Economics & Finance, Better Advances Press, Canada, vol. 1, pages 43-52, February.
    9. Bosker, E.M., 2006. "On the aggregation of eurozone data," Economics Letters, Elsevier, vol. 90(2), pages 260-265, February.
    10. Mike Artis & Andreas Beyer, 2004. "Issues in Money Demand: The Case of Europe," Journal of Common Market Studies, Wiley Blackwell, vol. 42(4), pages 717-736, November.
    11. Dreger, Christian & Wolters, Jürgen, 2014. "Money demand and the role of monetary indicators in forecasting euro area inflation," International Journal of Forecasting, Elsevier, vol. 30(2), pages 303-312.
    12. Detken, Carsten & Adalid, Ramón, 2007. "Liquidity shocks and asset price boom/bust cycles," Working Paper Series 732, European Central Bank.
    13. Berger, Helge & Harjes, Thomas & Stavrev, Emil, 2008. "The ECB's monetary analysis revisited," Discussion Papers 2008/14, Free University Berlin, School of Business & Economics.
    14. Rajaguru, Gulasekaran & Abeysinghe, Tilak, 2008. "Temporal aggregation, cointegration and causality inference," Economics Letters, Elsevier, vol. 101(3), pages 223-226, December.
    15. Joaquim Vieira Ferreira Levy & Alessandro Calza & Dieter Gerdesmeier, 2001. "Euro Area Money Demand; Measuring the Opportunity Costs Appropriately," IMF Working Papers 01/179, International Monetary Fund.
    16. Greiber, Claus & Setzer, Ralph, 2007. "Money and housing: evidence for the euro area and the US," Discussion Paper Series 1: Economic Studies 2007,12, Deutsche Bundesbank, Research Centre.
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    Cited by:

    1. Dreger, Christian & Wolters, Jürgen, 2016. "On the Empirical Relevance of the Lucas Critique: the Case of Euro Area Money Demand," EconStor Open Access Articles, ZBW - German National Library of Economics, pages 61-82.
    2. Matteo Barigozzi & Antonio Conti, 2013. "On the Stability of Euro Area Money Demand and its Implications for Monetary Policy," LEM Papers Series 2013/11, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    3. Dreger, Christian & Wolters, Jürgen, 2014. "Money demand and the role of monetary indicators in forecasting euro area inflation," International Journal of Forecasting, Elsevier, vol. 30(2), pages 303-312.
    4. Bofinger, Peter & Ries, Mathias, 2017. "Excess saving and low interest rates: Theory and empirical evidence," CEPR Discussion Papers 12111, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

    Money demand; inflation; excess liquidity; cointegration analysis;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money

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