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A remarkable development seen in recent years is the pronounced decline in euro area M1 velocity vis--vis a moderate decline in short-term interest rates, which represent the most natural opportunity cost for M1, suggesting an increase in the interest rate elasticity of M1 demand. In fact, estimating a theoretically plausible and stable demand function for M1 in the euro area is possible, if a functional form of money demand allowing for an interest rate elasticity decreasing in size with the level of the interest rate is imposed. This finding would apparently suggest that the decline in inflation and nominal interest rates in Europe experienced in the run-up to the euro should have naturally brought about an increased degree of preference for liquidity without any fundamental change in agents preferences. To test the validity of this conclusion, a time-varying parameters model is estimated through Kalman filter on the level of real M1, which is able to test simultaneously the stability of the parameters and the functional form of the demand for euro area M1. In this case, results clearly suggest the double log function to be very close to the true deep functional form of M1 demand in the euro area, consistent with the findings of Chadha, Haldane and Janssen (1998) for the United Kingdom and of Lucas (2000) for the United States.At the same time, there is evidence of an increased interest rate elasticity in M1 demand in the most recent years, presumably associated with the transition to the new environment prevailing from the start of Stage Three of EMU.

money demand: The case of extremely low-interest rate

Bank of Canada working papers are theoretical or empirical works-in-progress on subjects in economics and finance. The views expressed in this paper are those of the authors. No responsibility for them should be attributed to the Bank of Canada. ISSN 1701-9397 2

Uncovering interest-elastic money demand:

This paper quantifies some of the general equilibrium costs of inflation for the UK, under the assumption that individuals hold cash to economise on ‘shopping-time’. It tests whether or not money balances tend to a finite number as nominal interest rates tend to zero, and investigates how sensitive are the welfare implications of rates of inflation above the Friedman rule to this test. The paper then explores how uncertainties about the shape of the money demand curve translate into uncertainties about these welfare costs of inflation. A key uncertainty is the existence of a satiation point for money balances. We show using Monte Carlo tests that without observations at nominal interest rates very close to zero, the power of satiation tests can be very low. This finding may also be important for evaluating how/whether monetary policy could stabilise the economy in the event of a shock large enough to require that nominal interest rates are driven to the region of zero. 2 HOW UNCERTAIN ARE THE WELFARE COSTS OF INFLATION? 1

The Working Paper series of the Oesterreichische Nationalbank is designed to disseminate and to provide a platform for discussion of either work of the staff of the OeNB economists or outside contributors on topics which are of special interest to the OeNB. To ensure the high quality of their content, the contributions are subjected to an international refereeing process. The opinions are strictly those of the authors and do in no way commit the OeNB.

Abstract not found

Prepared for the Festschrift in honour of Charles Goodhart to be held on 15-16

In this paper we perform a meta-analysis of empirical money demand studies involving more than 500 individual money demand estimations and analyze whether the wide variety of results can be explained by characteristics of the studies. We find that estimates for the income elasticity of money are systematically and significantly higher if broader definitions for the monetary aggregate are used. The inclusion of wealth tends to cause lower estimates. In addition, we also investigate the impact of various other variables, econometric methods, details of the specification and macroeconomic variables on the size of estimated income elasticities and. Our overall conclusion is that the wide variety of estimated income elasticities can only be partly attributed to the imprecision of estimation, differences in the study characteristics and to different macroeconomic environments. JEL-Code: