Abstract
China has undertaken numerous economic reforms since 1978, including the abolishment of the fixed exchange rate system and adoption of a “managed floating exchange rate” regime in 2005. In the present study, we examined money demand in China by employing quarterly data after China adopted the new exchange rate system (from 2006Q1 to 2016Q1). To consider currency substitution, demand for money that includes exchange rate in addition to income and inflation is estimated. By incorporating the CUSUM and CUSUMSQ tests for stability in conjunction with cointegration analysis, we find M2 is a better measurement of monetary aggregate because it is cointegrated with its determinants and it is also stable. We also find strong evidence of currency substitution for M2.
Highlights
Money demand is a crucial macro topic because it forms the link between the monetary aggregates and some important macro variables
We examined money demand in China by employing quarterly data after China adopted the new exchange rate system
By incorporating the CUSUM and CUSUMSQ tests for stability in conjunction with cointegration analysis, we find M2 is a better measurement of monetary aggregate because it is cointegrated with its determinants and it is stable
Summary
Money demand is a crucial macro topic because it forms the link between the monetary aggregates and some important macro variables. Money demand in China attracts a lot of attention, especially after 1980’s. This is because China has undergone dramatic economic reforms since 1978, resulting in rapid growth of the economy. The literature on money demand in China includes but is not limited to [1] [2] [3] [4] [5]. The previous literature has employed standard estimation technique or cointegration techniques to estimate money demand in China from different aspects such as the definition of monetary aggregate, the variables
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