No. 219 - An Econometric Analysis of Money Demand in Italy

The paper presents quarterly and monthly econometric estimates for money demand in Italy, based on the recently redefined broad aggregate M2. Due to financial innovation and the introduction of new instruments for Treasury's funding, in the first half of the eighties money demand was unstable. In the following years, the velocity of M2 stabilised, enhancing its role in monetary policy. The paper presents a quarterly equation in which net financial wealth is the scale variable in the 1975-79 period, while more recently (1983-1992) this role is performed by domestic demand. In line with previous studies, we argue that this specification reflects a positive shift in the demand for Treasury's securities in the first half of the eighties, which reduced the demand for money as a store of value. The monthly equation is estimated over the 1983-1992 period, so as to reduce the impact of the instability. In the specification search, we considered, as additional criteria, forecasting performance and coherence between the quarterly and monthly equations. The estimated long-run elasticities of the final quarterly and monthly equations are coherent. Their forecasting performance is satisfactory in 1991 and in the first part of 1992; following the foreign exchange crisis in the Summer of 1992, signs of instability emerge.