MONEY DEMAND STABILITY AND INFLATION PREDICTION IN THE FOUR LARGEST EMU COUNTRIES

Abstract

ABSTRACTIn this paper, we analyze the money demand functions of the four largest EMU countries and of the four‐country (EMU‐4) aggregate. We identify reasonable and stable money demand relationships for Germany, France and Spain as well as the EMU‐4 aggregate. For the case of Italy, results are less clear. From the estimated money demand functions, we derive both EMU‐4 and country‐specific measures of money overhang. We find that the EMU‐4 overhang measure strongly correlates with the country‐specific measures, particularly since the start of EMU, and is useful to predict country‐specific inflation. However, it generally does not encompass country‐specific money overhang measures as predictors of inflation. Hence, aggregate money overhang is an important, but by far not an exhaustive, indicator for the disaggregate level.