chapter  8
26 Pages

Money demand in China: Evidence from a bounds testing cointegration approach


Demand for money plays an important role in macroeconomic analysis. The stability issue in money demand functions becomes an interesting area for researchers to test the effectiveness of monetary programmes. A number of studies on the relationship of money, financial development and economic growth in China have been well demonstrated by economists in the past (Chow 1987; Chen 1989; Yi 1993; Qin 1994; Huang 1994; Tseng et al. 1994; Girardin1996; Arize 2000; Gu 2004). Finding a stable money demand function is generally considered essential for the formulation and conduct of efficient monetary policies. In recent years, the Chinese economy has undergone profound changes. China’s economic reforms, rapid growth, structural changes and dramatic monetary expansion have been of major interest to economists and provide a useful explanation of money demand in China. Many of these studies demonstrate that a long-run relationship exists between money demand and its determinants. Some of the studies showed that the demand for money in China has changed significantly in response to economic reform (Yi 1993; Qin 1994). The conventional study of money demand in China is based on a framework which suggests that money demand is generally determined by some scale variables such as income and opportunity cost like domestic interest rate. With the rapid liberalization of the financial markets of recent years in China, some special features since reform have become apparent: the monetization process accompanied by rapid income increase of both individuals and enterprises has boosted money demand; wages as part of income has changed significantly during the reform; household savings have been sensitive to changes in price levels and interest rates. These features are of increasing importance to the determinants of money demand. The objectives of this study, therefore, are twofold: first, we try to find a more appropriate and satisfactory money demand function in China. Second, we try to explore a few more other influences regarding the nature of money demand behaviour and intend to establish the empirical suitability of the extended demand for money function for the Chinese economy. The influences of economic reforms will be highlighted.