Money demand in china revisited: Some new empirical evidence

Abstract

Over the last decade, the Chinese economy has begun to experience a shift from a system of direct macroeconomic control to a more indirect one. At the same time, rapid growth in currency stocks in circulation has been taking place. The ability of the central bank to forecast the quantity of money that Chinese consumers will demand while maintaining a certain level of national income and an acceptable rate of inflation has become an important issue faced by bank officials and policy makers. Failure in this regard can lead to economic instability and its consequences. Thus, the development of a demand for money equation appropriate for China is of the utmost concern. Pioneering work along these lines has been undertaken by Chow (1987) and Feltenstein and Farhadian (1987). Chow argued that his evidence indicates that the quantity theory provided a reasonable first approximation for the demand for money in China. Feltenstein and Farhadian theorized that, since Chinese prices were controlled by the central authority and shortages at these prices were commonplace, the appropriate money demand function would have as arguments perceived prices and perceived anticipated inflation, not the comparable magnitudes which were in fact released to the public. l The purpose of this article is to continue this exploratory work with an updated sample which runs to the end of 1987. A reasonably general demand for money equation is specified which admits approaches implied by previous work as special cases. Since the intention in this study is to focus on household demand for money, we use the most narrowly defined concept of money possible, namely currency in circulation. The reason is that in China currency in circulation is the only true medium of exchange. Demand deposits are not checkable and in fact can best be considered equivalent to savings deposits in the U.S .* The remainder of this article is organized as follows. In the second section we