On the use of area-wide models in the Euro-zone

This paper investigates the legitimacy of using area-wide models in predicting aggregate variables in the Euro-area. We aim to compare the performance of area-wide versus national specific models for modeling money demand when using different aggregation schemes. A generalized Grunfeld and Griliches criterion and the Vuong test are used to discriminate between competitive models. Results show that the use of different aggregation methods is not irrelevant. In fact, due to the volatility of the exchange rates, the aggregate models fit better than the disaggregate whenever we employ ECU exchange rates. However, for fixed exchange rates expressed in Euro, the disaggregate models outperform the aggregate ones. This paper was written during my visiting research period at the Department of Economics, University of Southampton. I wish to thank John Aldrich, Jan Podivinsky, Grayham Mizon and Akos Valentinyi. Financial support of the Universita degli Studi “Roma Tre” and the Marie Curie fellowship (HPMT-CT-2001-00353) are gratefully acknowledged.