IMF Working Papers

Broad Money Demand and Asset Substitution in China

Author/Editor:

Ge Wu

Publication Date:

June 1, 2009

Electronic Access:

Free Download. Use the free Adobe Acrobat Reader to view this PDF file

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. 2009/131

Subject:

Capital markets Demand for money Deposit rates Exchange rate arrangements Exchange rates