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International currency substitution and the demand for money in the euro area

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  • Lebre DE Freitas, Miguel

Abstract

Using quarterly data for the period from 1983:Q1 until 2019:Q4, we identify a stable money demand relationship for the euro area M3, with the US long-term interest rate as a regressor, together with the domestic interest rate and income. This specification is consistent with the open economy liquidity services approach to money demand, in light of which the ownership of money is separate from portfolio decisions. Our results suggest international currency substitution, pointing to interdependency of monetary policies, even in a context of floating exchange rates. In the short-run analysis, we find that excess liquidity helps predict nominal money but not the price level. In general, our findings cast doubt on the usefulness of the information content of M3 to analyse prospective inflation in the euro area.

Suggested Citation

  • Lebre DE Freitas, Miguel, 2022. "International currency substitution and the demand for money in the euro area," Economic Modelling, Elsevier, vol. 117(C).
    • Handle: RePEc:eee:ecmode:v:117:y:2022:i:c:s0264999322003017
    DOI: 10.1016/j.econmod.2022.106064
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    More about this item

    Keywords

    Euro area; Money demand; Capital flows; Portfolio theory; International currency substitution;
    All these keywords.

    JEL classification:

    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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