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Money demand in the euro area: new insights from disaggregated data

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Abstract

Conventional money demand specifications in the euro area have become unstable since 2001. We specify a money demand equation in deviations of individual euro area Member States variables from the euro area average and show that the income elasticity as well as the interest rate semi-elasticity remain stable. The corresponding deep parameters of the utility function have not changed fundamentally. Aggregate money demand instability does therefore not result from altered standard factors determining the preference for holding money. Instead, other factors determine the aggregate monetary overhang. Since monetary developments cannot easily be explained by changing preferences, they should be closely monitored as they may actually be a sign of other factors.

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Notes

  1. When specifying a money demand equation, this phenomenon can be taken into account by formulating a non-linear relationship between the money stock variables and the interest rate variable(s) and/or by specifying interest rates in log-form which implies that a precentage point reduction in nominal interest rates has a proportionally greater impact upon money holdings the lower the level of interest rates.

  2. Driscoll (2004) specifies a money demand equation in deviations of US states from the US average.

  3. National contributions to euro area M3 exclude currency in circulation as its location cannot be determined. A country’s national contributions to euro area monetary aggregates are defined as liabilities of domestic monetary financial institutions (MFI) to the whole euro area non-MFI sector. As such, e.g., German households’ and enterprises’ short-term deposits held with branches and subsidiaries of German MFIs in Luxembourg are part of Luxembourg’s contribution to euro area M3. However, the amount of deposits from and loans to euro area residents outside the domestic country is very low. As such, it can be assumed that national contributions to M3 are driven by macroeconomic developments in the individual euro area countries.

  4. Data are computed by adding and subtracting the following components of the “Aggregated balance sheet of euro area monetary financial institutions, excluding the Eurosystem”: 2.2 − 2.2.1 − 2.2.2 − 2.2.3.2.3 − 2.2.3.3.2 + 2.3 + 2.4 − 2.4.3.

  5. Dynamic OLS was originally developed by Stock and Watson (1993), Kao and Chiang (2000) analyze its properties in a panel context. See also Kao et al. (1999) and Pesaran and Smith (1995).

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Authors and Affiliations

  1. Directorate General Economic and Financial Affairs, European Commission, Rue de Loi 200, 1049, Brussels, Belgium

    Ralph Setzer

  2. Bruegel, Brussels, Belgium

    Guntram B. Wolff

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  1. Ralph Setzer
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  2. Guntram B. Wolff
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Correspondence to Ralph Setzer.

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The views expressed in this paper are the author’s alone and do not necessarily correspond to those of the European Commission.

Appendix

Appendix

Table 5 Johansen cointegration rank tests (trace statistics)
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Table 6 Overview of money demand studies for the euro area since 2001 (selection)
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Setzer, R., Wolff, G.B. Money demand in the euro area: new insights from disaggregated data. Int Econ Econ Policy 10, 297–315 (2013). https://doi.org/10.1007/s10368-012-0214-7

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