Money Demand in the Euro Area: Where Do We Stand (Today)?

IMF Working Papers, November 1, 2002

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Money Demand in the Euro Area: Where Do We Stand (Today)?

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Bibliographic details

• Authors: Zenon Kontolemis
• Published: November 1, 2002
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451859423.001

Summary findings

• The analysis confirms the existence of a stable long-run money demand in the euro area.
• The estimated money demand equation implies a smaller equilibrium M3 growth than the European Central Bank's reference value of 4½ percent.
• Stability of long-run money demand does not imply continuous market equilibrium; periods of disequilibrium can be long and adjustment slow.
• The gap between the low estimated equilibrium growth rate and the actual growth rate for M3 can be explained by a velocity shock, identified in the paper as the sharp fall in equity prices in the last two years.
• Events over the last two years suggest characteristics of the money market that warrant different treatment in policy communication.

Interpretation and analysis

• A stable long-run money demand coexists with potential prolonged disequilibrium and slow adjustment dynamics.
• Velocity shocks (linked here to sharp equity price declines) can produce substantial deviations of actual M3 growth from estimated equilibrium growth.
• The estimated equilibrium M3 growth being below the ECB reference value of 4½ percent points to potential misalignment between reference benchmarks and underlying demand fundamentals.

Policy recommendations and communication implications

• Monetary policy communication should place less emphasis on month-to-month developments in M3, given:
  • the possibility of long-lasting disequilibria, and
  • the influence of velocity shocks on short-term M3 dynamics.
• An alternative approach to communicating monetary policy developments is advocated to account for slow adjustment and episodic velocity shocks.

Keywords and topics covered

• Asset prices; Demand for money; Financial markets; Inflation; Money; Money markets; Personal income; Price stabilization; Prices
• Specific technical terms appearing in the analysis: adjustment terms, Cointegration, EMU, reference value, Taylor Rule, velocity trend, money demand equation, money demand function, WP

Money Demand in the Euro Area: Where Do We Stand (Today)?, IMF Working Paper No. 2002/185.

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