Money and credit dynamics in the euro area

Abstract

The thesis focuses on the development of money and credit in euro area countries. Most central banks use monetary aggregate growth as a target to regulate their banking system which then affect their whole economy. Howeverthe , after 2008 financial crisis, more and more economists claim the importance of price credit. Thus we a try to find stable benchmark equation to interpret the development path of money and credit. To find out the drivers behind, we introduce housing prices, equity prices and cross border bank lending. The first two also shows the relation between macro-economy and financial market. The third potential driver displays the impact of macroeconomic imbalance on money and credit. According to my study, the rise of housing prices may cause increase of money and credit creation in euro area countries, particularly before the period 2008. This might because the growth of housing prices indicates the increase of household wealth, they have more potentials to use money for transaction and investment. Respect to equity prices, the impact on money is pretty weak. While it shows negative effect on credit creation. This could be interpreted from an adjustment of investment portfolios' perspective. If equity prices increase, investor chase for equity instead of money/credit. We include the cross-border bank lending in the study. Because we thought that if a country could borrow more from abroad, then it may have more space/potentials to create money and credit in their domestic market. Our thesis provide positive empirical evidence on this view. In the last chapter, I talk about the causality between deposits and loans as a starting research of causal relation between money and credit. According to traditional monetary theory, only when residents deposit their money in a bank, loans can be created. However, in modern economy, for example in England, the truth is that credit/loans are a number which are created without the support of deposits. Thus we would like to figure out whether the traditional monetary theory is still valid in euro area countries or not. The problems is then whether deposits leads loans creation or the other way around. According to my study, we find the two causal directions both exist. We cannot deny one or another. This put much more challenge on central banks' regulation.