Solution Of The Problem Of Excess Liquidity

Nowadays, excess liquidity has become a very serious problem for China' s economic operation. Generally speaking, excess liquidity means oversupply of money. Currently, the excess liquidity appears as rapid growth of money supply, accompanying with overheated stock market and property market. From historical experiences of other countries, if the problem was not handled with properly, it would exert negative effects on economy, such as inflation, the imbalance of investment structure and the boom of speculation, causing the forming of economic bubble. In recent years, scholars have begun to research on this problem but no one has conducted empirical study with data. There is also a popular opinion that excess liquidity is simply a problem of money supply and could be easily solved with contractionary monetary policy. Although there is much research about the transmission mechanism of monetary policy, most of them analyze the problem from qualitative perspective and use old data. In order to overcome these shortcomings, this paper uses VAR model, Johansen cointegration test to conduct empirical analysis on the monthly data from January 2000 to December 2007 to research on the monetary transmission mechanism of China. We find that exchange reserve is the major cause for the increase of money supply and that there is mutual relationship between monetary supply and real output. There is no significant pass through from monetary supply to exchange rate as well as interest rate but interest rate, stock price and CPI do have significant impacts on output. Based on the empirical results, we think that excess liquidity is not a simple monetary problem. We conclude that China should continue to use quantitive monetary policy instruments to adjust macroeconomy, such as increasing reserve rate and public market operation. At the same time, a serious of other policies which are aimed to improve the long term economic fundamentals , such as adjustment of trade structure, perfection of financial market should be utilized. However, great attention should also be paid to the problems of limited liquidity of enterprises and sudden liquidity disappearance while solving the excess liquidity problem.