Revisiting the Money Demand Function in the Euro Area (in French)

35 Pages Posted: 31 Oct 2010

See all articles by Sanvi Avouyi-Dovi

Sanvi Avouyi-Dovi

Banque de France; ICN Business School

Matthieu Brun

affiliation not provided to SSRN

Alain Dreyfus

Banque de France

Françoise Drumetz

Banque de France

Vichett Oung

Banque de France

Jean-Guillaume Sahuc

Banque de France; Université Paris Ouest - Nanterre, La Défense - EconomiX

Date Written: May 2006

Abstract

recent years, the dynamics of M3 in the euro area have been driven by two factors: a strong preference for liquidity, observed between 2001 and 2003, followed by a normalisation, at a relatively moderate pace, of portfolio behaviour; as regards the counterparts, changes in M3 and net external assets were of comparable magnitude. These factors highlight the role of national and international portfolio shifts in monetary developments. Furthermore, the traditional specifications of the money demand function sometimes yield unsatisfactory results: instability of short and long-term coefficients, relatively large differences between the estimated and actual value of monetary aggregates, and significant changes in the number of long-run relations. Hence the idea of constructing a money demand function that excludes the external counterpart of M3 or, alternatively, introducing financial asset prices in the demand function of M3, as suggested by Friedman (1988).

First, the basic equation, based on the quantitative equation of money, was reestimated in order to verify, for example, whether extending the estimation period or revising certain variables would not result in a major change, notably in terms of the stability of the parameters or the number of structural relations. Indeed, this equation exhibits two instabilities (parameters and the number of long-run relations). Similar results are obtained when the external counterpart of M3 is not taken into account. However, by including European share prices, we obtain a substitution effect (significantly negative coefficient) of this variable and a better adjustment, without affecting the two long-run relations (money demand and the Fisher relation) discussed in the article published in Banque de France Monthly Digest No. 113. So, all other things being equal, a decline in European stock market yields would result in a rise in real money holdings and a decrease in the velocity of circulation of money. Equity market developments therefore appear to be a significant explanatory factor for the dynamics of M3 in the euro area.

Lastly, estimates of the real money gap, based on the money demand equation factoring in the substitution effect associated with European stock price developments, point to moderate but persistent excess liquidity in the euro area.

Note: Downloadable document is in French.

Keywords: recent years, the dynamics of M3 in the euro area have been driven by two factors: a strong preference for liquidity, observed between 2001 and 2003, followed by a normalisation, at a relatively moderate pace, of portfolio behaviour; as regards the counterparts, changes in M3 and net external asset

JEL Classification: C22, C32, E41

Suggested Citation

Avouyi-Dovi, Sanvi and Brun, Matthieu and Dreyfus, Alain and Drumetz, Françoise and Oung, Vichett and Sahuc, Jean-Guillaume, Revisiting the Money Demand Function in the Euro Area (in French) (May 2006). Banque de France Working Paper No. 142, Available at SSRN: https://ssrn.com/abstract=1699599 or http://dx.doi.org/10.2139/ssrn.1699599

Sanvi Avouyi-Dovi (Contact Author)

Banque de France ( email )

Paris
France

ICN Business School ( email )

13 rue du Marechal Ney
Nancy, 54000
France

Matthieu Brun

affiliation not provided to SSRN ( email )

Alain Dreyfus

Banque de France ( email )

Paris
France

Françoise Drumetz

Banque de France ( email )

Paris
France

Vichett Oung

Banque de France ( email )

Paris
France

Jean-Guillaume Sahuc

Banque de France ( email )

31 rue Croix des Petits Champs
75049 Paris Cedex 01
France
+33 1 42 92-49-52 (Phone)
+33 1 42-92-62-92 (Fax)

HOME PAGE: http:// https://sites.google.com/site/sahuceconomics/

Université Paris Ouest - Nanterre, La Défense - EconomiX ( email )

200 Avenue de la République
Nanterre cedex, Nanterre Cedex 92000
France

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