This paper through empirical observation investigates stableness of money demand map in China utilizing autoregressive distributed slowdown ( ARDL ) attack to co-integration. CUSUM and CUSUMSQ are employed to prove the stableness of the relationship between pecuniary sums ( M1 and M2 ) and their determiners. The consequences indicate that while there exists cointegration between money sums ( M1 and M2 ) and their determiners, merely M1 has a stable long tally relationship with its determiners. The mark of estimated exchange rate coefficient supports currency permutation phenomenon in China. This could be due to the mix of both currency permutation and wealth effects in the long tally. Furthermore, it determines the asymmetric effects of pecuniary policy on end product.

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Keywords: Money demand stableness, ARDL, CUSUM, CUSUMSQ, China


Sound pecuniary policy is important for any economic system and hence the preparation of such a policy and its behavior should be done every bit precise as possible. The cardinal issue on pecuniary policy is money demand. The being of stable and predictable relationship between money demand and its determiners is really of import for the preparation of pecuniary policy. It is hence necessary to prove the stableness of money demand as it has serious deductions on pecuniary policy. This can be achieved by utilizing co-integration techniques to analyze long tally relationship between money demand and its determiners. Furthermore, pecuniary sum ( M1 or M2 ) that can be found to be stable over clip can be regarded as a better sum for pecuniary policy hence the research on stableness of money demand can be used to order a better pecuniary policy.

In fact, the instability of the relationship between pecuniary sums and ends variables such as rising prices ( or income ) leads to the failure of the pecuniary policy. Mishkin F.S ( 1997 ) states that it is because of the instability of the relationship between pecuniary sums and ends variables such as rising prices and nominal income that U.S, U.K and Canada abandoned the scheme of pecuniary targeting and alternatively adopted rising prices aiming. However it is the really rising prices aiming that partially contributed to the diminution of the U.S GDP. This is because, Mishkin argues, the weak relationship between money and nominal income imply that as a state pursues pecuniary aiming policy by increasing or diminishing money supply, the end variable will stay unchanged.

Due to the deductions that stableness of money demand has on pecuniary policy, there has been a batch of research on this topic. One of the cardinal deductions that stable money demand has on pecuniary policy is that stable money demand ensures that money supply would hold predictable and coveted impact on other economic variables such as rising prices rate, involvement rate and national income. As Caporale and Gil-alana ( 2005 ) put it, stableness of money demand is a requirement for effectual preparation of pecuniary targeting policy. Many surveies on money demand stableness used Johansen ( 1988 ) and Johansen and Juselius ( 1990 ) co-integrating technique in analyzing the long tally relationship between money demand and its determiners. Examples of such surveies include Hafer and Jansen ( 1991 ) for United States, Adam ( 1991 ) and Johansen ( 1992 ) for United Kingdom, Hansen and Kim ( 1995 ) and Bahmani-Oskooee and Bohl ( 2000 ) for Germany. Most of these surveies concluded that M2 money sum is co-integrated with income and involvement rate.

China has non been an exclusion to this monolithic research on money demand map stableness. The literature on money demand in China includes Chow ( 1987 ) , Chen ( 1989 ) , Chan et Al ( 1991 ) , Ma ( 1993 ) , Huang ( 1994 ) , Xu ( 1998 ) and Huang ( 2000 ) . These surveies used regular appraisal techniques or recent co-integration technique. These documents focused on different facets of pecuniary policy in China such as ; the right explanatory variables to be included in the money demand map in China, definition of pecuniary sum, the effects of economic reform on money demand and the causal relationship between pecuniary sum and other macroeconomic variables. There were nevertheless many restrictions for these surveies. For case, the information was merely available up to mid 1990s and no paper used stableness trials such as the one suggested by Brown et Al ( 1975 ) . Besides most of these surveies did non take into history the impact of currency permutation on money demand as China continued to open up. However Wang, Y. ( 1999 ) included the currency permutation although there was no strong grounds that supports the impact of currency permutation.


Given the importance of a stableness of money demand map on pecuniary policy, it is really of import to prove whether pecuniary demand map is stable for China. This is because after finding which money sum has a stable long tally relationship with its determiners, so it will be recommended as a better tool in carry oning pecuniary policy. Besides it is of import to guarantee the money demand map is stable as this will intend alterations in pecuniary policy will hold the desired impact. This paper will follow a comparatively new co-integration technique called autoregressive distributed slowdown ( ARDL ) . Furthermore the asymmetric effects will be taken into history.


Quantity Theory of Money

The Classical economic experts, led by Irving Fisher, proposed the measure theory of money. They argued that motions in the monetary value degree consequence entirely from alterations in the measure of money. To exemplify their decision, the undermentioned equation was used ;

aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦ . ( 1 )

Where Measure of money

Speed of money

Price degree

end product

From equation ( 1 ) , both and are believed to be changeless hence any alteration in will hold to be accompanied by tantamount alteration of. Fisher reasoned that speed is determined by establishments in an economic system that affect the manner consumers conduct minutess and therefore it is changeless particularly in the short tally. He farther argued that produced in the economic system during normal times would stay at full employment degree, hence can besides be treated as changeless in the short tally.

Contrary to the Classical school of idea, Keynes argued that demand for money depends on the motivations of persons for keeping money. He classified motivations for keeping money into three classs viz. ; dealing motivation, precautional motivation and bad motivation. Another fluctuation was that Keynes emphasized the importance of involvement rate as a determiner of money demand. Keynes claim of opposite relationship between involvement rate and money demand was supported by many research workers including James Tobin ( 1947 ) . Tobin studied the nexus between involvement rate and money demand in the United State utilizing informations from 1922 to 1941. Tobin separated dealing balances from other money balances, which he called “ idle balances ” , under the premise that dealing balances were relative to income merely while idle balances are related to involvement rate merely. The mean degree of idle balances was so plotted against mean involvement rate on commercial paper for that twelvemonth. The determination was that there is strong grounds that there is reverse relationship between involvement rate and idle balances and he concluded that so money demand is antiphonal to involvement rate as Keynes claimed.

However, Driscoll and Ford ( 1980 ) used IS-LM attack to demo that stableness of money demand may non be a important issue as monetarist-Keynesian argument has made it to be. This is because, they ground, the money income multiplier would be stable merely if the demand for money were a stable map of income merely. If money demand map were a map of other variables such as involvement rate and wealth so it may be necessary to hold instability in demand for money map in order to hold a stable money-income multiplier.

By and large, it is believed that money demand has long run stable map with its determiners ; Stock and Watson ( 1993 ) argue that for this relationship to be predicted accurately, an of import requirement is long span of informations. To make this decision, they applied different methods of gauging co-integrating vectors to U.S money demand map from1900 to 1988 and tested parametric quantity stableness. A semi logarithm M1 money sum was taken as dependent variable while existent GDP while assorted long tally and short tally term involvement rate were used as graduated table and chance cost variables severally.


Due to the importance of stableness of money demand map on pecuniary policy, there has been a batch of research on this country utilizing Johansen ( 1988 ) and Johansen and Juselius ( 1990 ) co-integrating technique in analyzing the long tally relationship between demand for money and its determiners. However after Bahmani-Oske and Bohl ( 2000 ) suggested ARDL as a better co-integration attack, there has been a renewed involvement in the research on stableness of money demand utilizing this comparatively new co-integration attack. For case, McCandless and Weber ( 1995 ) examined informations from 110 states and concluded that correlativity between growing rate of money supply and rising prices rate was about 1. This strong positive relationship between money supply growing and rising prices rate is consistent with measure theory of money as proposed by Keynes. This correlativity nevertheless should non be interpreted as causality between the two variables. McCandless and Weber nevertheless found no grounds that supports the being of correlativity between rising prices or money supply and existent end product growing.

Although money supply has no effects whatsoever on income in the long tally, there is grounds that suggest correlativity between money and income in the short tally. Friedman and Schwartz ( 1963b ) concluded that faster money growing is normally followed by addition in end product. Their grounds was based on the survey 100 old ages U.S information. Like in the long tally instance, this correlativity should non be understood to be the causality between the two variables.

Friedman and Meiselman ( 1963 ) conducted a survey with the aim of proving whether pecuniary or financial policy was more of import in finding nominal income in the short tally. They reported that there was more stable and statistically important relationship between end product and money than there is between end product and expenditures. This survey received much unfavorable judgment from Modigian and Ando ( 1976 ) and De Prano and Mayer ( 1965 ) who argued that the theoretical account used by Friedman and Meiselman was mispecified.

In every bit much as the money demand map stableness has been widely researched, a important research was done on developed economic systems. It is hence of import to look at some research done for developing states. Sharifi-Renani ( 2007 ) studied the stableness of money demand map in Iran with two chief aims viz. ; 1 ) to cast visible radiation on co-integrating belongingss of M1 and M2 money sums, income, rising prices and exchange rate utilizing ARDL co-integrating technique and 2 ) to find the stableness of M1 and M2 money demand map. Some of the chief findings were that co-integration does non connote stableness between the variables and that M1 and non M2 has stable relationship with money demand determiners hence M1 can be taken as a better pecuniary sum for preparation of pecuniary policy.

A similar survey to the 1 conducted in Iran was carried out in Nigeria by Akinlo A.E ( 2005 ) . Unlike the survey in Iran, the findings were that it is M2 and non M1 that is co-integrated with income, involvement rate and exchange rate.


To gauge demand for money in China utilizing autoregressive distributed slowdown ( ARDL ) attack to co-integration

To prove the stableness of money demand over clip in China ( utilizing M1 and M2 to stand for money demand )

To prove the asymmetric effects of pecuniary policy on end product


Money demand stableness has been researched extensively utilizing the conventional co-integration method. However, some writers such as Bahmani-Oske and Bohl ( 2000 ) have proved that when two or more variables are co-integrated, it does non needfully intend there be long tally relationship between them. As a consequence some writers proposed that CUSUM and CUSUMQ trial should be incorporated into co-integration and mistake rectification theoretical account ( ECM ) . As a consequence, this paper will follow mistake rectification version of autoregressive distributed slowdown ( ARDL ) attack to co-integration. Unlike regular co-integration method, ARDL does non necessitate anterior cognition of the order of integrating of all the variables.


The conventional attack to money demand map is to presume that money demand depends on graduated table variable and the chance cost variable. The graduated table variable is normally represented by existent income or the existent ingestion outgo, whereas chance cost variable is represented by involvement rate on alternate assets. The general specification of money demand map is assumed to take the undermentioned functional signifier ;

aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦ . ( 1 )

Where = demand for money balances

Price degree

Real income

Opportunity cost variable

Inflation is used as a placeholder for involvement rate when covering with less developed states which usually have less developed fiscal markets. Examples of such instances include Bahmani-Oskooee and Tanku ( 2006 ) and Budina et Al ( 2006 ) . Exchange rate variable is included in equation ( 1 ) when covering with developing states due to currency permutation. The inclusion of exchange rates in a standard money demand map was foremost suggested by Mundell ( 1963 ) . Evidence of currency permutation in developing states was provided by Zamaroczy and Sa ( 2002 ) , Kang ( 2005 ) and Samreth ( 2008 ) who conducted a survey on Cambodia. Thus money demand map becomes ;

aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦ . ( 2 )

Where rising prices rate

Exchange rate

In this context, exchange rate is defined as the sum of domestic currency per unit of foreign currency. This implies that an addition ( lessening ) of can be understood as depreciation ( grasp ) of domestic currency against the foreign currency. In more expressed signifier, equation ( 2 ) can be rewritten as follows ;

aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦ . ( 3 )

Where = existent pecuniary sum ( M1 or M2 )

= existent income

= nominal effectual exchange rate

= rising prices rate

My Contribution

While most research workers use equation ( 3 ) with income, involvement rate ( or exchange rate ) and rising prices rate to stand for money demand equation, Friedman ( 1988 ) emphasized the importance of stock market activity in money demand map utilizing U.S information. There are two chief ways through which through which stock market activity can act upon money demand. First this can be through permutation consequence ; an addition in plus monetary values means investors would instead keep more assets than money. Second, an addition in wealth ( as plus monetary values addition ) may intend that portion of the extra additions may be stored as hard currency. Other writers such as Chowdhry ( 1996 ) , Thornton ( 1998 ) and Kia ( 2006 ) besides showed that stock monetary values form an of import portion of money demand for developed economic systems. Besides Baharumshah ( 2004 ) studied the demand for money map in Malaysia utilizing multivariate co-integration and mistake rectification theoretical account and found that stock monetary values have a important negative permutation consequence on long tally every bit good as short tally wide money demand ( M2 ) .

As mentioned before there has been a batch of research on money demand in China, but most of the surveies used conventional stableness trials and a few that used ARDL co-integration attack such as a recent survey by Bahmani-Oskooee, M and Wang, Y. ( 2007 ) ignored the consequence of stock monetary values on money demand. This paper will try to include this of import variable.

Morten, O. R. and Martin, S. tested the asymmetric effects of pecuniary policy in the U.S utilizing station war informations. The importance of proving for asymmetric effects is that it helps to find if the coefficients of explanatory variables are the same before and after a government. Furthermore, it can besides be tested whether positive or negative pecuniary policy dazes have different effects on end product, whether large or little dazes have different effects and whether low discrepancy negative dazes have asymmetric effects on end product. This paper will follow Markov Switching Vector Autoregressive ( VAR ) theoretical account as it was used by Krolzig ( 2006 ) to prove for asymmetric effects.


Harmonizing to Arango and Nadiri ( 1981 ) the mark of is expected to be positive while that of is expected to be negative. Appraisal of can either be negative or positive. If is defined as the figure of domestic currency per U.S dollar, so if additions so it means that the foreign assets in footings of domestic currency go more expensive. If this addition is caused by addition in wealth, so demand for domestic currency will increase therefore the mark of will be positive. But if consumers expect the domestic currency to depreciation farther in future, so they will keep more of foreign currency and less of domestic currency which implies that in this instance the mark of will be negative.


Perasan et Al ( 2001 ) introduced a new improved method of proving co-integration known as autoregressive distributed slowdown ( ARDL ) . Bahmani and Oskooee ( 2000 ) conducted a survey on Germany money demand map and concluded that although variables in the money demand map were co-integrated, the parametric quantities in the theoretical account were unstable, therefore farther invalidating the conventional reading that co-integration between money sum and its determiners imply being of stable long tally relationship. Unlike traditional co-integration where order of co-integration of all variable has to be known, ARDL does non necessitate to sort variables as I ( 1 ) or I ( 0 ) or carry on pre-testing unit root trial. Under standard co-integration attack, non merely should the order of integrating be known, but the variables should be integrated of the same order. This requirement causes jobs where variables integrating order is different. Hence autoregressive distributed slowdown ( ARDL ) , proposed by Pesaran et Al ( 1996,2001 ) , becomes an option. The mistake rectification version of ARDL theoretical account related to variables in equation ( 1 ) can be specified as follows ;

aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦aˆ¦.. ( 4 )

The void hypothesis of no co-integration is defined by and is tested against the option of and is tested by F-test. The determination to either accept or reject the void hypothesis is based on the set of critical values suggested by Pesaran et Al ( 2001 ) . Persaran et al suggested two sets of critical values in which 1 set is computed with the premise that all the variables in equation ( 4 ) are I ( 1 ) and another set of critical values is computed with the premise that the variables are I ( 0 ) . The determination regulation is that if the computed F statistic is higher than the appropriate upper edge of the critical value, so the void hypothesis is rejected. If it lies within both the lower and upper bounds so the trial is inconclusive. If the F trial supports the being of co-integration, so the 2nd measure of ARDL can be conducted. In this measure, Akaike Information Criteria ( AIC ) or Schwarz Bayesian Criteria ( SBC ) is used to take the slowdown length. The chief difference between this F-test and the conventional manner of carry oning F-test is that here there is no demand to sort variables as I ( 0 ) or I ( 1 ) .

Expected Decision

The coefficients of the explanatory variables are expected to hold the same marks as the theory dictates. Furthermore, decisions should include findings about which of the pecuniary sums ( M1 or M2 ) has a long tally stable with the determiners of money demand. This money sum will so be recommended as a better pecuniary sum for behavior of pecuniary policy in China. Given the literature on this topic, the pecuniary demand map is expected to be stable.


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