Skip to main content
Article thumbnail
Location of Repository

A portfolio balance approach to Euro-area money demand in a time-varying environment

By Stephen G. Hall, P. A. V. B. Swamy and George S. Tavlas

Abstract

As part of its monetary policy strategy, the European Central Bank has formulated a reference value for M3 growth. A pre-requisite for the use of a reference value for M3 growth is the existence of a stable demand function for that aggregate. However, a large empirical literature has emerged showing that, beginning in 2001, essentially all euro area M3 demand functions have exhibited instability. This paper argues that a proper understanding of the determination of money requires a portfolio analysis where the demand for broad money is seen as just one element in the wealth portfolio. Under this framework, wealth is the variable that constitutes the total budget constraint on the holdings of assets, including money, and changes in equity prices are a key transmission channel of monetary policy. Understanding money behaviour thus requires good data on euro area wealth which at present do not exist. Our basic premise is that there is a stable demand-for-money function but that the models that have been used until now to estimate euro area money-demand are not well-specified because they do not include a measure of wealth. Using two empirical methodologies - - a co-integrated vector equilibrium correction (VEC) approach and a time-varying coefficient (TVC) approach - - we find that a demand-for-money function that includes wealth is stable. The upshot of our findings is that M3 behaviour continues to provide useful information about medium-term developments on inflation

Topics: Money demand, VEC, time varying coefficient estimation, Euro area
Publisher: Dept. of Economics, University of Leicester
Year: 2008
OAI identifier: oai:lra.le.ac.uk:2381/7483

Suggested articles

Citations

  1. (2006). A Worldwide System of Reference Rates‖, including comments by Marc Flandreau, doi
  2. (2006). An Alternative Definition of Market Efficiency and Some Comments on its Empirical Testing‖,
  3. (2006). Capital Flows, Capital Account Liberalisation and the Mediterranean Countries‖,
  4. (2006). Computational Intelligence in ExchangeRate Forecasting‖,
  5. (2006). Corporate Ownership Structure and Firm Performance: Evidence from Greek Firms‖, doi
  6. (2006). Determinants of Bank Profitability in the South Eastern European Region‖,
  7. (2006). Europe‘s Hard Fix: The Euro Area‖, including comments by Mario I. Blejer and Leslie Lipschitz, doi
  8. (2006). Exact Elliptical Distributions for Models of Conditionally Random Financial Volatility‖,
  9. (2006). Exchange-Rate Arrangements and Financial Integration in East Asia: On a Collision Course?‖, including comments by doi
  10. (2007). Foreign Exchange Intervention and Equilibrium Real Exchange Rates‖, doi
  11. (2007). Home Bias and Purchasing Power Parity: Evidence from the G-7 Countries‖, doi
  12. (2006). How Homogenous are Currency Crises? A Panel Study Using Multiple Response Models‖,
  13. Identification of a Loan Supply Function: A Cross-Country Test for the Existence of a Bank Lending Channel‖, doi
  14. (2006). Inflation Forecasts and the New Keynesian Phillips Curve‖,
  15. (2007). M3 demand stability: Implications for the usefulness of money in monetary policy making. European Central
  16. (2006). Market Conduct, Price Interdependence and Exchange Rate Pass-Through‖, doi
  17. (2006). Modeling the Components of Market Discipline‖,
  18. (2006). Monetary Policy Rules under Heterogeneous Inflation Expectations‖,
  19. Monetary Unions, External Shocks and Economic Performance: A Latin American Perspective‖, including comments by Enrique Alberola, doi
  20. (2007). Money and monetary policy: The ECB experience 1999-2006. European Central doi
  21. (2006). Proposal for a Common Currency Among Rich Democracies‖ doi
  22. (2006). Regional Currency Arrangements in North America‖, including comments by Steve Kamin and doi
  23. (2006). Regional Currency Arrangements: Insights from Europe‖, including comments by Lars Jonung and the concluding remarks and main findings of the workshop by Eduard Hochreiter and George Tavlas, doi
  24. (2007). Short-Term Capital Flows and Growth in Developed and Emerging Markets‖,
  25. (2006). Technical and Allocative Efficiency in European Banking‖, doi
  26. (2007). The Balance Sheet Channel of Monetary Policy Transmission: Evidence from the UK‖, doi
  27. The Effect of the Euro on Foreign Direct Investment‖, doi
  28. (2007). The Interaction between Mortgage Financing and Housing Prices in Greece‖, doi
  29. (2007). The Narrative Approach for the Identification of Monetary Policy Shocks in a Small Open
  30. (2006). The New Keynesian Phillips Curve and Inflation Expectations: Re-specification and Interpretation‖, doi
  31. The New Keynesian Phillips Curve and Lagged Inflation: A Case of Spurious Correlation?‖, doi

To submit an update or takedown request for this paper, please submit an Update/Correction/Removal Request.