Research Of Excess Money Supply In China (1979-2009): Theory And Evidence

The relationship between Currency, prices and output is one of the most valuable problems in the theory of Monetary Economics. The reason not only lie in its value of the significant guidance to monetary policy, but also lie in Controversy and uncertainty of key problems in the theory itself, the latters just are power sources of the monetary theory development and prosperity since several centuries. The topic of this paper just is a derivative and the Chinese special case of the proposition. Since the early 1990s, excess money supply in Chinese macroeconomic running began to be concerned by the authorities and the academics. Over the past 20 years, there are existed many literatures surrounding this topic, but the explanation to the causes of the problem is still full of controversy. Progressing slowly and difficult to break in theory studying, once leaded to the problem study make silent. However, since the American financial crisis, the government of U.S began to execute quantitative easing monetary policy (QE) continuously, which made all of the world awash with liquidity. Under the current foreign exchange system of China, Chinese domestic money supply faced with tremendous pressure. The problem of China's excess money supply is placed before the authorities and theoretical researchers again.In accordance with the monetarism theory, excess money supply will be reflected in price inceasing eventually, if the amount of money supply is too much higher than the demand of economy healthy running, no doubt, it will undermine the healthy development of the economy. Therefore, some domestic researchers look excess money supply as a "cage tiger" to image its potential dangers. However, from the view of actual operation situation of Chinese economy since reforming and opening up, the inflation levels in most years were controlled in a moderate level, those years which the price index in the two-digit are rare, even there was exsit deflation in some years of the late 1990s and the early 2000s. These phenomenas remind us that four questions are needed to consider seriously: First, Is really there excess money supply in China? Second, if it really existed, how much the scale is it? Third, how to explain its causes? Fourth, how should we deal with it? This paper just is a thinking and researching results based on the above four questions.This article is divided into five sections generally:The first section includes ChapterⅠand ChapterⅡ, this section starting from the analysis of money supply, prices, output relations deviating "Chinese Moeny Puzzle" in macroeconomic operation since reform and opening up of China, proposes main problems of this paper, and defines the concept of excess money supply. Second, we reviewed and combed all of the literatures, summarized and generalized the current research situation, research methods, and all kinds of explanation to its causes, which purpose is construct research framework for the second part. As an introduction of this article, whose objective of Chapter I is to propose the background, main content, research ideas, methods and possible innovations and shortcomings of this paper. The Chapter II reviewed and sorted out literatures of excess money supply, and described the similarities and differences of excess money supply concept and research methods in the foreign and domestic literatures, and summarized 8 hypotheses of the causes in domestic literatures emphatically.The second part includes ChapterⅢ, which main purpose is to construct theoretical models and analytical framework, combed the two measurement frameworks of excess money supply systematically, which based on the balance of money supply and demand and based on the Fisher trading equation, summarized their respective theoretical origins, the process of development and evolution, compared and summarized the two frameworks strengths and weaknesses, and then, selected the measurement framework in this paper.The third part includes ChapterⅣ, this chapter focused on improving and amending the trading equation measurement framework, and re-measured the excess money supply scale in China. First, this chapter relaxed the suppose that money velocity is constant in trading equation framework, and on this basis, improved and corrected the measure formula of excess money supply; Second, we try to established a model which can associated the real economy with the virtual economy, used annual data to measur the integrated money velocity, and compared it with the results through traditional method calculated; Finally, we restored the integrated money velocity to the adjusted trading equation, and re-measured the scale of the excess money supply in China.The fourth section includes the Chapter V and ChapterVI, this section caugut tightly the dual times background of Chinese economy internal transformation and external opening, we chosed the process of Monetization of economy, high saving rates, fiscal revenue changes, capital market development, Foreign Exchange Reserves surge and RMB outside flowing, which are six aspects of the typical economic facts, used statistics data and modern econometric techniques to empirically study the factors and causes of the Chinese excess money supply. The ChapterV focus on studying the causes of excess money supply under the internal economic transformation of China. This chapter took Chow breakpoint tests on the excess supply scale of M2 firstly, and found the data had a structural change in 1994, According to this conclusion, we divided the sample into two phases:(1979-1993) and (1994-2009); Second, by selecting the four typical economic facts during Chinese economic internal transformation, we used of cointegration test, Granger causality test, impulse response function and other methods, tested diterminants of excess money supply of China in the two phases respectively.ChapterVI focused on researching causes of excess money supply in China under the open economy conditions. This chapter continued the analysical ideas of the previous chapter, under the open economy condition, and chosed the surge of Foreign Exchange Reserves and the facts of expanding scale of offshore RMB circulation as clues, through establishing a four variable VAR model, which included the excess money supply, foreign exchange Reserve that not been written off, net domestic credit and exchange rate changes. Firstly, we used cointegration test, Granger causality test, impulse response functions, variance decomposition technique to examin the Foreign Exchange Reserve, exchange rate changes and other factors under the open economy conditions caught the impact on excess money supply. Secondly, we reviewed and summarized many literatures of offshore RMB circulation, We used money supply multiplier model to estimate the stock size of offshore RMB circulation, and its impact to the excess money supply in domestic.The fifth section includes ChapterVII, this part took a brief review and summary for the full text, summarized the main conclusions of this paper, and proposed some targeted policy recommendations.The main conclusions of this paper are:First, during more than 30 years since china's reforming and opening up, there is indeed existe excess money supply in most years, but the actual excessive size is significantly lower than calculated results of most traditional literatures, which can be reflected by two sets of data:(1) the average size of excess money supply on MO, Ml, M2 are 2.9%,3.9% and 5.5% respectively, which are significantly lower than the calculate results which base on traditional methods (8.7%,9.5%,12.6%); (2) Among the 31 samples range, the amounts of year that appeared excess money supply on MO, M1, M2 three levels are 21,23 and 23 respectively, significantly less than the calculate results which base on traditional methods (26,28 and 28). The conclusion show that:for a long time, the scale of excess money supply in China may be overvalued, the "cage tiger" that people worried may be not so terrible as people imagined.Second, the excess money supply of M2 changed differently in two stages:in the first period, the trend of excess money supply is relatively stable (σ=9.7), but mean is larger (7.1%); In the second period, the trend of excess money supply is relatively volatile (σ=11.7), but the mean is smaller (4%). This conclusion is consistent with the results that financial innovation and the virtual economy development make the money velocity lower in some classic papers(Bordo&Jonung,1987).Third, the results of empirical research on the causes of excess money supply under China's economic internal restructuring show that:(1)The process of monetization of economy (M2/GDP) has a good explanation for the cause of the first stage of the excess money supply, but it has no significant statistical meaning after 1994. This shows that the process of monetization of economy of China began to appear inflection point in 1994. (2)Both household savings rate and government savings rate both are Granger causes of the excess money supply formation, but the directions of the two influence is different: in the first stage, the change trend of the excess money supply was in the same direction with the trend of household saving rate, but in the opposite direction with the trend of government savings rate; in the second stage, those influence directions just happen reverse changes. (3)The fiscal deficit is an important reason for the causes of excess money supply. (4)The rapid development of capital market and expansion of asset prices in China since 1994, absorbed and divided parts of excess money supply,which can well explain the reason of average size of excess money supply significantly lower than the previous stageFourth, under the open economy condition, Foreign Exchange Reserves that unwritten off have significant Granger impact on the formation of the excess money supply, but the impact of exchange rate fluctuation and the net domestic credit are not significant, moreover, the results of impulse response function and variance decomposition support this conclusion. This indicated that the surge in Foreign Exchange Reserves have replaced the net domestic credit, and became the most important factor to base money supply in central bank.Fifth, in the process of RMB internationalization, the scale of offshore RMB demand and the circulation expanding continuously, those RMB deposited outside have the money multiplier effect through the money multiplier amplification, which effect to China's excess money supply can not be ignored. So, it may be one of important external factors that causes the excess money supply in China.The main innovations in this paper are:1. This paper attempted to take the money velocity of the real economy and the virtual economy into a same framework, and we used Chinese macroeconomic data and micro-enterprise data to measure the integrated money velocity actually, the operation results show that the integrated velocity of MO, M1, M2 change in U-curve over time, which consisted with the results of some classic literatures (Bordo& Jonung,1987), but have significant differences with results on traditional money velocity calculated mothod(V=PY/M).2. This paper relaxed the assumption of money velocity as a constant variable under traditional framework, we restored the calculated results of the integrated money velocity, and re-measured the scale of China's excess money supply. The results show that the scale of excess money supply in China were overestimated by the most literatures for a long time. This conclusion has important value for explanation of "Chinese Money Puzzle". 3. This paper hold dual perspectives of the internal transformation and external opening of Chinese economy closely, incorporated the stock and flow factors of offshore RMB into the explanation of the causes of the excess money supply for the first time. This method is significantly different with the perspective of most current literatures on this topic, which supply a new angle to research the causes of excess money supply in China.The deficiencies in this paper are:1. In the empirical study, the sample length of time series is short (only 31), that may affect accuracy of integrated money velocity, which may weaken the scientificity and reliability of the conclusions.2. The integrated money velocity econometric model in this paper need further improvement, modification, testing,and re-modification. Re-measurement of the money velocity is the basis of our research, but the most literatures had inherited the assumption of money velocity is a constant variable, so that, there are fewer literatures to discuss money velocity calculated models or methods, this paper just want to make some attempt in this field, the stability of the conclusion need further test and correct.3. This paper dedicated to research those problems of the existence and causes of excess money supply in China, there are no special chapters to discuss some basic monetary theory questions. Actually, the charming of monetary theory can remain evergreen lie in the controversity and non-unifromity of the basic propositions. So we believe that the research and judgement on the basic purpositions are more important than the "Whether China has excess money supply?"The directions of further research of this paper are:1. This paper need to further research the mechanism of excess money supply impact on economic and finance. An moderate inflation is a lubricant of economic operation, as the same way, a moderate excess money supply may be not threat for economy growth, so whether there is an appropriate boundary in different countries and different development stage, those problems need to further study.2. When we research the segregation mechanism of the development of capital market and the changes of asset price to the excess money supply, we need to consider the development of real estate and its price changes. In the past 20 years, the development of real estate market in China experience from small to large-scale change, the real estate properties changed from consumer goods to investment goods too. So, we need to take those real estate factors into research framework in this paper.3. On the relation between money supply and outputs, we need further study the current status of U.S. and China:U.S. dollar is the most important reserve currency, according to Federal Reserve data at January 23,2011, the size of M2 stock was about 58 trillion yuan, and it created off U.S. GDP was about 96.2271 trillion yuan. However, RMB as an non-international currency, the size of M2 stock was about 72 trillion yuan, and it created off China GDP was about 39.7983 trillion yuan at the same period. How should we provide a scientific and rational explanation for these data? We need further research.4. Government's action has important effect to currency issuance, especially, since the sub-prime crisis, Chinese government has executed a large-scale investment plan and loose monetary and credit policy. These policies have resulted in the rapid growth of China's money supply, then how to study the impaction of government acts on excess money supply qualitatively and quantitatively is the next research direction of this paper.