China's High M₂/GDP

M2/GDP is an index to indicate the monetizing level of a country. Since the year of reforming and opening-up, China's M2/GDP had been increasing to 1.56 by 2006, higher than the current level of developed countries as well as other transformation countries. In 1990s most scholars attributed high M2/GDP to the rising monetary level of our economy. The market reform made more and more goods and services transact by money, which increased the demand of M2 and led M2/GDP to grow. However, the monetizing process reached top in the mid-1990s and other factors should be found to explain the increasing M2/GDP. These views included high ratio of savings, high ratio of bad assets in banking system, undeveloped financial market, the development of capital market, etc. These explanations almost focused on the perspectives of finance and gross quantity. Recently the research gradually turned to the analysis of economy and structure. This paper uses structural analysis method to discuss the cause of high M2/GDP in China from the perspective of income distribution based on the achievements of former research.This paper is organized in four parts. ChapterⅠis introduction, including the background, research summary, research method, difficulty & innovation, and structure plan.ChapterⅡand ChapterⅢare the main parts. ChapterⅡfalls into four sections. The first section builds a theory analysis model from IS-LM Model. In this model, the marginal ratio of money supply and national income is decided by four parameters: marginal propensity of consume (a), sensibility of money demand to income (k), interest rate coefficient of investment (d), interest rate coefficient of money demand (h). The following analysis focuses on the above four parameters. SectionⅡanalyzes two basis: one is that the conduction between interest rate and investment is blocked under the current mechanism of interest rate formation and inappropriate investment system, which means a small d; the other is small h coming from low market level of interest rate and less developed finance market. Small d & h are also supported by many other researches. It is reasonable that d & h will keep relative stable regarding the slow process of interest rate reform. SectionⅢdiscusses the relation of income distribution and M2/GDP based on a. On the one hand, income distribution gap causes the whole marginal propensity of consume and consume rate to decrease. The lack of consumption directly influences GDP. Meanwhile, marginal propensity of consume also influences multiplier of government finance and investment, weakening their functions to GDP. On the other hand, the income distribution gap aggravates the unbalance of consumption, investment and external trade. Weak consumption cannot absorb all the domestic production ability, which flows out and turns into foreign exchange. These mass foreign exchanges become RMB, causing M2 to increase at a fast rate. That is why income distribution is one of the factors of high M2/GDP on the basis of marginal propensity of consume. The last section discusses the relation of income distribution and M2/GDP based on k. The high saving propensity of low-income class makes the bank savings deposits increase dramatically, so large scale of money lays down in the banking system. Meanwhile, high-income groups love to put their money into the capital market, most of which eventually precipitates inside. Money both in the banking system and the capital market has no positive function to the GDP, rendering M2/GDP to increase.ChapterⅢis empirical testing of the theory model proposed in chapterⅡ. Assume dm/dY as the explained variable Z, k as the first explanatory variable X1, (1-a)h/d as the second explanatory variable X2, so the theory model becomes the following regression function: Zi = a0+a1*X1i+a2*X2i+ui. First the stability testing of the three variables is given. The results show that time series Zi and X1i have good stability, while the stability of X2i is not so good. Luckily, all of them are I(1) process, which is the basis of co-integration testing. The result indicates that co-integration relation exists among the three variables. Next an error correction model is built, whose result is good, reflecting the dynamic relation between the explained variable and the explanatory variables. The conclusion of this chapter is that theory model built in chapterⅡis acceptable.The last part is conclusions and suggestions. The conclusion of this paper is that the conducting mechanism between income distribution and M2/GDP by the real economy and monetary economy is reasonable; the income distribution gap is one of the factors that cause high M2/GDP. The suggestions are given from the aspects of raising the revenue of low-income groups and farmers as well as improving the income distribution order.