Explaining Money Demand in China During the Transition from a Centrally Planned to a Market-Based Monetary System

Abstract

We examine the transition process from a centrally planned to a market-based monetary system in China, with the objective of giving a functional form to the transition in money demand. Applying the cointegrating Time-Varying Smooth Transition Regression model proposed by Choi and Saikkonen (2004) on a constructed dataset spanning the period from 1984 to 2010, and using a seasonal unit-root test developed by Hylleberg et al. (1990), our findings invalidate much of the earlier literature. Our examination of disaggregate as well as aggregate money balances yields the following findings; Households have an infinite demand for money at prevailing interest rates; enterprises have gradually gained decision-making authority over their deposits; Money is a complement rather than a substitute to capital and this has become more prominent over the period; the credit plan has ceased to be a significant driver of money holdings after 1997; In the aggregate monetary sphere, the deposit interest rate has gained only a minor role as a monetary instrument, and only since 2000.

Keywords: money demand, cointegrating time-varying smooth transition regression model, seasonal unit-root test, Chinese economy

JEL Classification: E41, O11, P52, P24, C51