Modeling Money Demand in China: Evidence from Cointegration Analysis

When monetary policy is not aimed at clearing the money market by using the nominal interest rate, as in China's case, money demand becomes an important analytical tool. This paper examines China's money demand in the long run with the cointegration analysis. We find that (i) real money balances is a function of real income and interest rate in the long run; (ii) real money balances react positively to changes in real income while negatively to those in interest rate in the long run; (iii) the impact of economic activity on real money demand is large while that of the interest rate is relatively small. Our finding implies that monetary aggregates in China have some useful indicator properties and monetary authorities should watch its movement closely.