Does Digital Finance Change the Stability of the Money Demand Function? Evidence from China

The stability of the money demand function is critical to understanding how money affects inflation and output, and how to optimize the operation of monetary policy. Taking China as an example, this paper studies whether digital finance changes the stability of money demand function by using cointegration technology. We find that digital finance has different effects on the stability of money demand functions at different monetary aggregate. Digital finance does not change the stability of M0 demand function, nor does it have an effect on the unstable M1 demand function, but it changes the previously stable M2 demand function. We further analyze the impact of two services of digital finance - payment service and assets management service - on the stability of demand functions for M0, M1, and M2. For the payment service, the results imply that the impact of digital finance on stability is M0 > M1 > M2, while for the assets management service, the result runs to the opposite. Finally, consistent with recent studies, our findings support that if Divisia index is applied, the impact of digital finance on the stability of money demand function will be weakened