Broad Money Demand and Asset Substitution in China

Author/Editor: Wu, Ge
Publication Date: June 01, 2009
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate
Summary: 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.
Series: Working Paper No. 09/131
Subject(s): Capital markets | Central bank policy | China, People's Republic of | Demand for money | Economic models | Exchange rate regimes | Exchange rates | Financial assets | Financial systems | Interest rates | Monetary policy | Private investment

Author's Keyword(s): Money demand | asset substitution | exchange rate | interest rate | China
Publication Date: June 01, 2009
Format: Paper
Stock No: WPIEA2009131 Pages: 30
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