Currency Substitution and Money Demand in Euroland

This paper tests the stability of the demand for money in the euro-area in the context of an open economy. A sample consisting of quarterly data covering the 1982:2–1999:3 period is considered. The main finding is that the U.S. dollar long-term interest rate plays a significant role in the European money demand relationship. This result holds for different combinations of variables forming the vector auto-regressive system and suggests that international monetary interdependency may be an important factor influencing the ECB monetary policy.This paper draws on an earlier version and was prepared while the author was at the Bank of Portugal (the usual disclaimer applies). It was presented at the 2003 Meeting of the Economic Modelling Network. The author acknowledges Luis Catela Nunes, Carlos Santos, Carlos Robalo Marques, Nuno Alves, and an anonymous referee for their helpful suggestions.