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Broad Money Demand and Asset Substitution in China

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  • Ge Wu
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    Abstract

    Recent changes to China''s financial system, in particular ongoing interest rate liberalization, gradual movement toward a more flexible exchange rate regime, and rapid development of capital markets, have changed substantially the environment in which monetary policy operates. In light of these changes, we estimate an error correction model using a General-to-Specific methodology and confirm that a stable broad money demand function exists taking proper account of asset substitution, with an income elasticity of less than unity. Current inflation is found to have a significant negative impact on the real money demand. However, money demand does not appear very sensitive to interest rates, possibly reflecting their partial liberalization. Changes in the exchange rate also do not affect money demand significantly, but expectations of a further renminbi appreciation since 2005 appears to induce more money demand. Stock prices are statistically insignificant despite recent investors'' interest in equity markets.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 09/131.

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    Length: 30
    Date of creation: 01 Jun 2009
    Date of revision:
    Handle: RePEc:imf:imfwpa:09/131

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    Keywords: Central bank policy; Economic models; Exchange rate regimes; Exchange rates; Financial assets; Financial systems; Interest rates; Private investment; money demand; equation; statistics; cointegration; inflation; monetary policy; demand for money; financial statistics; central bank; outliers; monetary fund; money supply; probability; standard error; dummy variable; survey; forecasting; standard errors; monetary assets; monetary targets; goodness of fit; aggregate demand; horizontal axis; hong kong monetary authority; statistic; monetary authority; confidence intervals; logarithms; explanatory power; theory of money; graphical analysis; maximum likelihood estimation; operations research; monetary data; normal distribution; number of parameters; covariance; autocorrelation; hypothesis testing; money market; number of variables; probability value; equations; equilibrium solution; monetary conditions; parsimonious model; vector autoregression;

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    References

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    1. Sunil Sharma & Neil R. Ericsson, 1996. "Broad Money Demand and Financial Liberalization in Greece," IMF Working Papers 96/62, International Monetary Fund.
    2. Feltenstein, Andrew & Ha, Jiming, 1992. "The link between macroeconomic adjustment and sectoral output in post-reform China," China Economic Review, Elsevier, vol. 3(2), pages 109-124.
    3. Chen, Baizhu, 1997. "Long-Run Money Demand and Inflation in China," Journal of Macroeconomics, Elsevier, vol. 19(3), pages 609-617, July.
    4. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
    5. de Brouwer, Gordon & Ericsson, Neil R, 1998. "Modeling Inflation in Australia," Journal of Business & Economic Statistics, American Statistical Association, vol. 16(4), pages 433-49, October.
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    8. Yu, Qiao & Tsui, Albert K., 2000. "Monetary services and money demand in China," China Economic Review, Elsevier, vol. 11(2), pages 134-148, December.
    9. Johansen, S., 1991. "Testing Weak Exogeneity and the Order of Cointegration in UK Money Demand Data," Papers 78, Helsinki - Department of Economics.
    10. Girardin, Eric, 1996. " Is There a Long Run Demand for Currency in China?," Economic Change and Restructuring, Springer, vol. 29(3), pages 169-84.
    11. Ma, Guonan, 1993. "Macroeconomic disequilibrium, structural changes, and the household savings and money demand in China," Journal of Development Economics, Elsevier, vol. 41(1), pages 115-136, June.
    12. Hafer R. W. & Kutan A. M., 1993. "Further Evidence on Money, Output, and Prices in China," Journal of Comparative Economics, Elsevier, vol. 17(3), pages 701-709, September.
    13. H. Yamada, 2000. "M2 demand relation and effective exchange rate in Japan: a cointegration analysis," Applied Economics Letters, Taylor & Francis Journals, vol. 7(4), pages 229-232.
    14. Taylor, M P, 1986. "From the General to the Specific: The Demand for M2 in Three," Empirical Economics, Springer, vol. 11(4), pages 243-61.
    15. Johansen, Soren & Juselius, Katarina, 1990. "Maximum Likelihood Estimation and Inference on Cointegration--With Applications to the Demand for Money," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 52(2), pages 169-210, May.
    16. Subramanian S. Sriram, 2001. "A Survey of Recent Empirical Money Demand Studies," IMF Staff Papers, Palgrave Macmillan, vol. 47(3), pages 3.
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    Cited by:
    1. Zuo, Haomiao & Park, Sung Y., 2011. "Money demand in China and time-varying cointegration," China Economic Review, Elsevier, vol. 22(3), pages 330-343, September.
    2. You, Kefei & Sarantis, Nicholas, 2012. "A twelve-area model for the equilibrium Chinese Yuan/US dollar nominal exchange rate," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 22(1), pages 151-170.
    3. Xiaowen Jin, 2012. "An Empirical Study of Exchange Rate Pass-Through in China," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 59(2), pages 135-156, May.

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