2013/11 | LEM Working Paper Series | |
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On the Stability of Euro Area Money Demand and its Implications for Monetary Policy |
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Matteo Barigozzi, Antonio Conti |
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Keywords | ||
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money demand; time–varying cointegration; price–earnings ratios; unemployment
rate; monetary policy
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JEL Classifications | ||
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E41, E52, C32
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Abstract | ||
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We revisit the usefulness of long-run money demand equations for the
European Central Bank. We first conduct a model evaluation exercise by
means of a recent time–varying cointegration test. A stable relation
for euro area M3 is not rejected by data only when accounting for both
a speculative motive, represented by international financial markets,
and a precautionary motive, proxied by changes in the unemployment
rate. Second, relying on this finding, we propose and estimate a novel
time-invariant specification for money demand which allows us (i) to
build a leading indicator of stock market busts and (ii) to describe
the anomalous behavior of M3 in the last decade. Excess liquidity
matters for both financial and price stability.
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