The Empirical Definition of Money in China1

Abstract

This paper employs both the reduced-form-regression approach and the factor analysis ap­ proach to analyze the empirical definition of money in China. In the factor analysis, it is found that there are two common factors shared by the financial assets under study. One represents li­ quidity and the other represents store of value. The results of the factor analysis and the reduced­ form-regression approach coincide and suggest that urban saving deposits are the best substitute for currency. For this reason, urban saving deposits and currency should be included in the narrow money definition, which is different from the definition set by the International Monetary Fund. Studies of money and monetary policy in China have traditionally adopted currency in circulation as the monetary medium. Historically, other financial assets were few. More recently the Chinese government and the International Monetary Fund have adopted two broader measures of money: Ml which is currency plus deposits of enterprises, government agencies and organizations and M2 which is Ml plus household deposits. This paper applies methods to China which have been used to develop empirical definitions of money in the West. A conclusion is that. none of the three definitions currently in use, i.e., currency, Ml or M2, are the best measures of the money supply based upon empirical criteria. The best definition of money for China is currency plus ur­ ban saving deposits. Empirical definitions of money have been based on three alternative ap­ proaches: (1) demand for money equations; (2) reduced-form-regressions; and (3) factor analysis. This paper develops an empirical definition of money for the Chinese economy using the latter two approaches. These two approaches, as opposed to the demand-for-money approach