Nonlinearities in the Dynamics of the Euro Area Demand for M1

The paper finds evidence of non-linearities in the dynamics of the euro-area demand for the narrow aggregate M1. A long-run money demand relationship is first estimated over a sample period covering the last three decades. While the parameters of the relationship are jointly stable, there are indications of non-linearity in the residuals of the error-correction model. This non-linearity is explicitly modelled using a fairly general Markov switching error-correction model with satisfactory results. The empirical findings of the paper are consistent with theoretical predictions of non-linearities in the dynamics of adjustment to equilibrium stemming from quot;buffer stockquot; and quot;target-thresholdquot; models and with analogous empirical evidence for European countries and the US