Euro Area Money Demand and International Portfolio Allocation: A Contribution to Assessing Risks to Price Stability

64 Pages Posted: 21 Aug 2008

See all articles by Roberto A. De Santis

Roberto A. De Santis

European Central Bank (ECB) - Directorate General Economics

Carlo A. Favero

Bocconi University - Department of Finance; Centre for Economic Policy Research (CEPR)

Barbara Roffia

European Central Bank (ECB)

Multiple version iconThere are 2 versions of this paper

Date Written: August 21, 2008

Abstract

The long-run relationship between money and prices in the euro area embedded in traditional money demand models with income and interest rates broke down after 2001. We develop a money demand model where investors hold a diversified portfolio with money, domestic and foreign stocks and long-term bonds in which, in addition to the classical wealth effect, also a size and an international portfolio allocation effects arise. The estimated model identifies three cointegrating vectors stable over the sample 1980-2007: a long-run money demand, which depends on income and all risky assets' returns, and two equilibria for the euro area and the US financial markets. Steady state equilibrium of nominal M3 growth is estimated to be about 7% in 2007 with large standard errors mainly due to uncertainty in asset prices. The gap between actual euro area M3 growth and model-based fitted or predicted values helps forecast euro area inflation.

Keywords: Euro area money demand, inflation forecasts, monetary policy, portfolio allocation

JEL Classification: E41, E44, E52, G11, G15

Suggested Citation

De Santis, Roberto A. and Favero, Carlo A. and Roffia, Barbara, Euro Area Money Demand and International Portfolio Allocation: A Contribution to Assessing Risks to Price Stability (August 21, 2008). ECB Working Paper No. 926. Available at SSRN: https://ssrn.com/abstract=1188508

Roberto A. De Santis (Contact Author)

European Central Bank (ECB) - Directorate General Economics ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany

Carlo A. Favero

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

HOME PAGE: http://www.igier.unibocconi.it\favero

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Barbara Roffia

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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