Money Demand in the Eurozone: Do Monetary Aggregates Matter?

The definition of money demand and the study of its stability are still relevant issues, as the effects of monetary policies are also analyzed on the basis of the movements in the demand for money. Therefore, understanding the functioning of money demand is extremely important for monetary policy decisions. In this paper we study money demand in the euro-area, investigating if its estimated stability is influenced by the monetary aggregate employed. This aspect is particularly relevant in the context of the European Monetary Union (EMU), as the European Central Bank (ECB) conducts monetary policy on the basis of the broad money aggregate M3 and one of the most relevant problems for monetary policy decisions in this area is the instability of money demand. By employing panel data techniques, we are able to show that the stability of the relation between money demand and its determinants changes depending on the monetary aggregate (M1, M2 or M3) employed as a proxy for money demand. Moreover, money demand is substantially more stable when M2 is considered. Then, by switching from M3 to M2 as the reference monetary aggregate can increase the estimated money demand stability and improve the performance of the ECB’s monetary policy. This result is also confirmed by splitting the sample in two separate groups of countries. Nevertheless, in less stable economies the impact of inflation on money demand is significantly higher, while in more stable economies the role of income is more relevant.