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.
The views expressed in this publication are those of the authors and do not necessarily reflect the views of the BIS or its member central banks.