Money and Inflation in China

Abstract

Recent debates on monetary condition and inflation pressures on the Mainland call for an analysis on the inflation dynamics and their main determinants. A natural starting point for the econometric analysis of monetary and inflation developments is the notion of monetary equilibrium. This paper presents an estimate of the long-run demand for money in China. The estimated long-run income elasticity is rather stable over time and consistent with that estimated in earlier studies. The difference between the estimated demand for money and the actual money stock provides an estimate of monetary disequilibria. These seem to provide leading information about CPI inflation in the sample period. At the current conjuncture, the measure suggests that monetary conditions have tightened since the macroeconomic adjustment started in early 2004. Additionally, an error-correction model based on the long-run money demand function offers insights into the short-run and long-run inflation dynamics.