New Evidence on the Motives for Holding Euro Area Money

Abstract

This study focuses on the role of equity and labour markets for holding euro area money. Equity affects money demand positively through wealth effects (financial transaction motive) and negatively via substitution effects from the expected return on equity (speculative motive). A precautionary motive is captured by the annual change in the unemployment rate. The empirical results show that equity and labour markets do matter for euro area money demand since 1983. This finding is robust across different proxies for the augmented motives and a shorter sample starting in 1994. Copyright � 2010 The Author. Journal compilation � 2010 Blackwell Publishing Ltd and The University of Manchester.

On the Stability of Euro Area Money Demand and Its Implications for Monetary Policy

“…(a) Calza et al . (); (b) Dreger and Wolters (); (c) De Bondt (); (d) De Santis et al . () Notes : Residuals of money demand equations (percentages) computed according to the indicated references and rescaled to have zero mean.…”

“…Finally, as we show in the rest of this paper, two specifications have a particular role in studying money demand. First, De Bondt () focuses on the role of equity and labour market dynamics. The latter motive is measured by changes in unemployment which represent a precautionary saving motive: money is hoarded when labour market weakens, i.e.…”

“…when the unemployment rate rises. Moreover, De Bondt () shows that the annual change in unemployment is strongly correlated with consumer confidence sentiment. An improvement in labour markets conditions, normally associated to a higher GDP and, thus, to a higher demand for real balances, also lowers long‐run precautionary demand for money.…”

“…Indeed, we gain more insights on the determinants of money demand when we consider those models based on labour markets (De Bondt, ) and international financial markets (De Santis et al ., ). Results are in the second part of Table .…”

“…First, we run a model evaluation exercise of different specifications of EA money demand proposed by the literature (Carstensen, ; Dreger and Wolters, , and many others; see Table for a complete list), in order to determine which ones, if any, are stable and therefore effective for policy analysis. We consider a quarterly data set spanning the sample from 1980:Q1 to 2016:Q3 and we find that most of the considered models are indeed unstable after 2001, although improvements are observed when including either (i) the spread between EA and US price‐earnings ratios (De Santis et al ., ), or (ii) the changes in EA unemployment rate (De Bondt, ). Second, we develop further this result by proposing, estimating, and identifying a new stable model for money demand relying on both those motives.…”