Economic Reforms and the Stability of Long-run Demand for Money in China: Some Results from Co-integration Tests

The demand for money function is a macroeconomic relationship of crucial importance. It forms the key linkage between the monetary sector and the real sector in basic macroeconomic models, and has direct policy relevance as the channels and effects of monetary policy are captured by the functional form and parameter values of this relationship. Indeed, the formulation and effectiveness of monetary policy largely depend on the existence and stability of the relationship between monetary aggregates and economic activities, price, and interest. This chapter aims to investigate the implication of economic reforms on money demand in China, focusing on the long-run stability of broad and narrow monetary aggregates. The issue of stability of the demand for money arises naturally both from China’s economic transformation and its inadequate treatment in most previous studies.