The Functional Form of the Demand for Euro Area M1

A remarkable development seen in recent years is the pronounced decline in euro area M1 velocity vis-a-vis a moderate decline in short-term interest rates, which represent the most natural opportunity cost for M1. This paper endeavous to estimate a demand function for euro area M1, in particular by investigating its functional form. While the double log function is found to be very close to the true "deep" functional form of M1 demand in the euro area for most of the sample period, consistent with the findings of Chadha, Haldane and Janssen (1998) for the United Kingdom and of Lucas (2000) for the United States, there is also evidence of an increased interest rate elasticity in M1 demand in the most recent years, presumably owing to the transition to the new policy environment prevailing from the start of Stage Three of EMU and the associated decline in nominal short-term interest rates