Money demand stability and currency substitution in six European countries (1980-1992)

This paper discusses the main potential sources of instability of money demand in Europe originating from institutional changes in the financial system and currency substitution. Money demand equations might appear unstable if the dynamic specifications are too rigid. This can largely be overcome by using error-correction models. Once this model is applied, money demand in the countries reviewed is reasonably stable and economically well behaved. Estimations show that currency substitution is an important feature of financial behaviour in Europe. It supports the proposition that an EC-wide money stock would possess stability properties superior to individual countries' money demand.