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A Monthly Monetary Model with Banking Intermediation for the Euro Area

Author

Listed:
  • Annick Bruggeman
  • Marie Donnay

Abstract

In this paper we gradually construct a monthly encompassing monetary model on the basis of its two constituting components: a money demand and a loan demand model. Each of the three models pays special attention to the intermediation role of banks by modelling the relation between the retail bank interest rates and the short-term market interest rate. The encompassing monetary model accounts for the possible interactions between money and loans induced by the intermediation role of the banking sector, which is represented in this paper by its interest rates setting behaviour. Our analysis indicates that, over the period January 1981-September 2001, our monthly money demand model corroborates the existing quarterly evidence. The same does not hold for our loan demand model where a correcting variable for the mergers and acquisitions wave of 1999-2000 is added as an exogenous variable to stabilise the loan demand equation. Our encompassing monetary model rejects the frequently used assumption of complete separability in the pricing of loans and deposits. It provides also some evidence on the existence of a bank lending channel in the euro area, although there is some indication of a possible instability in the link between money and loans towards the end of the sample period. The estimation of the Structural-VECM highlights very rich dynamics in the system. The common trends method results in the identification of seven shocks: an aggregate supply shock, an inflation objective shock, an institutional shock, a money demand shock, a loan demand shock, a banking shock and a monetary policy instrument shock. The first three shocks are permanent shocks, responsible for the main variability in the macro-economic variables in the long run; while the last four shocks are temporary ones, affecting the economy only in the short and medium run.

Suggested Citation

  • Annick Bruggeman & Marie Donnay, 2003. "A Monthly Monetary Model with Banking Intermediation for the Euro Area," Working Papers Department of Economics ces0309, KU Leuven, Faculty of Economics and Business, Department of Economics.
  • Handle: RePEc:ete:ceswps:ces0309
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    Keywords

    Euro area; Cointegration; Structural VECM; Money demand; Loan demand; Banking intermediation.;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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