The money demand function for the Euro area: one step beyond

Sanvi Avouyi-Dovi, Françoise Drumetz and Jean-Guillaume Sahuc

No 07-08, Documents de recherche from Centre d'Études des Politiques Économiques (EPEE), Université d'Evry Val d'Essonne

Abstract: This article sets out to re-examine the money demand function for the euro area. Traditional specifications often yield unsatisfactory results: instability of short and long-term coefficients; relatively large differences between estimated and actual value of variables; and significant changes in the number of long-term relationships, etc. Using a standard Vector Error Correction Model, we find that the usual specification is indeed unstable. However, introducing an European equity price gives rise to a more stable system. Furthermore, recursive estimates confirm the relative stability of long-term coefficients. Estimates of the real money gap, based on the money demand equation including equity prices, point to moderate, albeit persistent, excess liquidity in the euro area in the recent years. The real money gap contains information about future inflation but this content may have diminished since 2001.

Keywords: Demand for money; stability; financial assets; substitution effect (search for similar items in EconPapers)
JEL-codes: C11 C51 E52 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2007
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Persistent link: https://EconPapers.repec.org/RePEc:eve:wpaper:07-08

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