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

36 Pages Posted: 19 Jul 2022

See all articles by Stephen G. Hall

Stephen G. Hall

University of Leicester - Department of Economics

G. Hondroyiannis

Bank of Greece

P.A.V.B. Swamy

Bureau of Labor Statistics

G. S. Tavlas

Bank of Greece

Date Written: October 1, 2007

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 considers euroarea money demand in the context of the portfolio-balance framework. 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.

Keywords: Money demand, VEC, time varying coefficient estimation, Euro area

JEL Classification: C20, E41

Suggested Citation

Hall, Stephen G. and Hondroyiannis, G. and Swamy, Paravastu A.V.B. and Tavlas, George, A portfolio balance approach to Euro-area money demand in a time-varying environment (October 1, 2007). Bank of Greece Working Paper No. 61, Available at SSRN: https://ssrn.com/abstract=4163982 or http://dx.doi.org/10.2139/ssrn.4163982

Stephen G. Hall

University of Leicester - Department of Economics ( email )

Department of Economics
Leicester LE1 7RH, Leicestershire LE1 7RH
United Kingdom

G. Hondroyiannis

Bank of Greece ( email )

21 E. Venizelos Avenue
GR-10250 Athens
Greece
+011 301 3202429 (Phone)
+011 301 3233025 (Fax)

Paravastu A.V.B. Swamy

Bureau of Labor Statistics

2 Massachusetts Avenue, NE
Washington, DC 20212
United States

George Tavlas (Contact Author)

Bank of Greece ( email )

21 E. Venizelos Avenue
GR-10250 Athens
Greece
+30 10 323 7224 (Phone)
+30 10 323 3025 (Fax)

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