Money growth and inflation in China: New evidence from a wavelet analysis

Abstract

This paper provides a fresh new insight into the dynamic relationship between money growth and inflation in China by applying a novel wavelet analysis. From a time-domain view, our findings show strong but not homogenous links between money growth and inflation in the mid-1990s and the period since the early 2000s. Especially since the early 2000s, China's monetary policy has achieved much better performance in terms of inflation management compared to previous years. From a frequency-domain view, we find that money growth and inflation are positively related in one-to-one fashion in the medium or long run whereas they deviates from such a positive relation in the short run due to temporary shocks and significant lag effects. We can also conclude for China that the long-run relationship between M0 growth and inflation supports the modern quantity theory of money (QTM), while the medium-run relationship between M1 growth and inflation as well as M2 growth and inflation supports the modern QTM. In general, however, our results fit well with the fact that China has experienced economic transitions and structural adjustments in monetary policy over the past two decades. Based on the above analysis, this paper provides an overall view of monetary policy operations and some beneficial implications for China.