The Demand for Money in China: A Reassessment Using the Bounds Testing Approach

This paper investigates the demand for money in China using annual data covering 1977-2006. To this end, we apply a newly-developed bounds testing technique to overcome the inherent limitations in testing for unit roots prior to testing for the existence of a level relationship between a dependent variable and a set of regressors. Our results clearly identify the long-run money demand relationship among real narrow money (or real broad money), real income, and nominal interest rates for China. The estimated long-run income elasticity and interest semi-elasticity are, respectively, 0.884 (0.915) and -0.034 (-0.002), using the real M1 (M2) equation. Our estimates of the long-run elasticity are consistent with previous studies, but they are towards the lower end of existing estimates. The results of the parameter stability test reveal that both M1 and M2 money demand are stable for China.