Economic Sentiments and Money Demand Stability in the CEECs

Abstract

This paper aims at building a money demand function that takes account of the heterogeneities of the Central and Eastern European Countries (CEECs) in the context of the European integration. We extend the traditional specification of money demand to capture the effects of a change in agents’ expectations regarding the dynamics of economic activity. The traditional determinants of the demand for money (real GDP, interest rate, inflation rate) are found to be significant and have the expected sign. Above this, we also find that the role of economic sentiments - captured through the European sentiment indicator (ESI) - is significant in explaining the money demand: consumers’ and investors’ gloomy expectations concerning future economic developments trigger an increase in the domestic money demand, due to precautionary reasons. Our results also suggest that a currency substitution effect, against both euro and USD, is present in the CEECs.