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Broad Money Demand and Asset Substitution in China

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  • Ge Wu

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.

Suggested Citation

  • Ge Wu, 2009. "Broad Money Demand and Asset Substitution in China," IMF Working Papers 2009/131, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2009/131
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    3. Indranarain Ramlall, 2012. "Broad Money Demand in Mauritius with Implications for Monetary Policy," Journal of Economics and Behavioral Studies, AMH International, vol. 4(8), pages 436-448.
    4. Chan, M. L. Luke & Cheng, Wang & Deaves, Richard, 1991. "Money demand in china revisited: Some new empirical evidence," Journal of Asian Economics, Elsevier, vol. 2(1), pages 137-144.
    5. 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.
    6. Mr. Arto Kovanen & Jihad Dagher, 2011. "On the Stability of Money Demand in Ghana: A Bounds Testing Approach," IMF Working Papers 2011/273, International Monetary Fund.
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    8. Mr. Arto Kovanen, 2011. "Does Money Matter for Inflation in Ghana?," IMF Working Papers 2011/274, International Monetary Fund.
    9. 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.
    10. 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.

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