The Study On China’s High Money Growth And Its Relationship With Inflation

Since the reform and opening up,China’s money supply has been growing rapidly.The average annual growth rate of M2 is over 18%,higher than the sum of the economic growth rate and inflation rate for a long period.Why money supply grew so fast? What kind of relationship exists between money growth and inflation in China? This thesis conducted a deep research on that.In the front section of this paper,we studied the issue of China‘s high growth rate of money supply.Firstly,from the perspective of monetary statistics,this paper analyzes the high growth monetary internal structure to get the main sources of high money growth.The 3 main channel of base money supply are foreign exchange,trading of securities and re-lending.Process of money creation include lending mainly derived deposits,to buy foreign assets derived deposits,purchase of securities and derivative deposit business conduct interbank deposits derived.Over the past 20 years,China’s money supply is growing rapidly,with an average annual growth rate of broad money over 18.5%.Based on the money multiplier theory,the vast majority of high growth is driven by base money‘s high growth,the money multiplier only have a greater contribution during the Asian financial crisis period.Further research finds that,the high growth of base monetary was mainly due to high growth in foreign exchange,whose contribution to base money growth rate is up to 98%.Money multiplier increased at first,then decreased and then stabilized.The early rise was mainly due to the impact of currency rate decline,the mid-term decrease was primarily due to the statutory deposit reserve ratio rise,the later stabilized was mainly due to the prudent use of the statutory reserve ratio policy and pay more attention to structural monetary policy.The monetary composition structural analysis finds that,the broad money growth was mainly due to the high growth of quasi-money.Further subdivided,among all parts of quasi-currency,the residents‘ savings deposits contributed the most part for the growth of broad money.The unit time deposits grow fastest,which contributed more than 20% to broad money growth.The monetary source formed structure analysis finds that,money growth mainly comes from loans,followed by foreign exchange.In the period of rapid economic growth after joining the WTO,foreign exchange contribution to broad money growth rate of 44%,the contribution rate decreased significantly after the international financial crisis in 2008.This is in line with the facts that China’s financial markets are underdeveloped,corporate finance,and economic development mainly depends on the actual bank loans and foreign exchange funds.From the perspective of money demand and economic development,this paper explained the high growth of money supply‘s deep economic and financial reasons,which reflects the actual changes in China’s economic growth mode and the financial system characteristics.Since the 1990 s,among the "troika",the contribution rate of consumption to GDP was declining,while the contribution rate of investment and exports were rising.Declining consumption means savings rate get higher,the result may prove the higher household savings contribution rate conclusions.Under a financial system which indirect financing pattern in a dominant position,the more investment increased,the more loans needed,thereby increasing the money supply sources of credit creation.Under the mandatory exchange settlement system and the background of RMB exchange rate appreciation,the increased exports brought more foreign exchange,thereby increasing the money supply by foreign exchange channel creation.Nextly we studied the relationship between China‘s high money supply growth and inflation.Firstly,for that it is rare to find some literature that studies the relationship between them really from ―long-term‖ perspective in the existing research.Based on the mathematical definition and testing method of "long-term monetary neutrality",this paper tested the long-term impact on the real output growth rate and inflation of China’s high money supply growth.We find that: based on the traditional inflation indicators,long-term monetary neutrality does not hold in our country.The high money supply growth not only didn‘t have an effect on real output in the long run,there is no complete conversion to the inflation rate also.The traditional inflation indicators don‘t contain asset price volatility information.Based on the dynamic factor index method,we constructed a generalized price index that contains asset price fluctuations information.Based on that index,we further tested long-term one-to-one relationship between money growth and inflation in China.The results show that: based on the generalized inflation indicator,long-term monetary neutrality is correct in our country.The paper further did an in-depth study on the impact of China‘s asset markets development to the relationship between money growth and inflation.We put forward three kinds of effect that the impact of capital market development on the traditional relationship between money and inflation,namely mediating effect,shunt absorbing effect and deflationary effect.Among them,the deflationary effect occurs only in case of severe credit crunch after the asset bubble burst.Similar situations have not yet happened,that is to say,in our country currently,deflationary effect is not obvious.Under normal circumstances,the impact of asset market developments on the relationship between money growth and price depends on the contrast in strength between the mediating effect and the shunt absorbing effect.When the mediating effect is stronger than the shunt absorb effect,the relationship between money growth and price would be positive,if the shunt absorbed effect is stronger than the mediating effect,the impact on the relationship between money growth and price would be negative.The empirical study find that the development of the stock market and real estate market do have some impact on the relationship between money growth and price.The impact of the stock market is positive,that is,its mediating effect is strong.The impact of the real estate market is negative,that is,its shunt absorbing effect is stronger.The real estate market diverted some money supply growth,so the money supply growth did not completely flow into the general price field,and thus the growth rate of the money supply did not convert to the traditional inflation completely.In the short term,the relationship between money growth and inflation is quite complex and uncertain.Given that there is little study on the relationship between money growth and inflation under different economic backgrounds in the current domestic literature,the paper conducted a study.Firstly,using TVP-VAR method,this paper analyzes the differences of the relationship between money growth and inflation at different stages of economic development.The results show that the inflation effect of money growth is obviously time-varying.The inflation effect of money growth is relatively stronger in the following periods: 2000-2001,2003-2008.While the inflation effect of money growth is relatively weaker in the following periods: 1997-1999,2009-2013.Development of asset markets has changed the mechanism that money growth affects the general prices.Money supply growth has an immediate impact on the housing market,the stock market and other asset markets,but needs a longer lag period to have an impact on the real economy.During the periods of rapid asset markets development,inflation response to money growth shocks requires longer time to reach the maximum.Its shunt absorbing effect is more significant.The paper further analyzes the differences of relationship between money growth and inflation under different economic status.Using the threshold regression model,we select different variables as threshold variable,dividing the state of the economy into different status,the study finds that: in the short term,the inflation effect of China’s money growth has little to do with inflation expectations or the credit growth rate,but the level of economic growth,money growth and the status of assets market are all related.The Faster the economic grows,the greater the inflation effect of money growth is.The higher the money supply grows,the more obvious the inflation effect of money growth is.Prosperity asset markets will divert some money growth,making the inflation effect of money growth weakened.The innovation of this paper is mainly reflected in the following aspects:Firstly,from the perspective of monetary statistics,this paper analyzed the high growth monetary internal structure to get the main sources of high monetary growth.From the perspective of money demand and economic development,this paper explained the high growth of money supply’s deep economic and financial reasons.Secondly,based on the mathematical definition and testing method of "long-term monetary neutrality",this paper conducted rigorous tests on the long-term one-to-one relationship between on China’s money supply growth and inflation.Based on the dynamic factor index method,we constructed a generalized price index that contains asset price fluctuations information.Based on that index,we further tested long-term one-to-one relationship between money growth and inflation in China.Thirdly,we put forward three kinds of effect that the impact of capital market development on the traditional relationship between money and inflation,namely mediating effect,shunt absorbing effect and deflationary effect.We further did an empirical test by SVAR model using the related Chinese data.Fourthly,this thesis studied the different relevance intensity between money and inflation under different periods of economic development and different economic status,using TVP-VAR model and Threshold Regression model,respectively.The implications of this paper are:Firstly,research on monetary issues should not only focus on the perspective of total amount,but also pay attention on the structured perspective.Secondly,it is of great significance to study more representative price indicators that contain asset price volatility information.The macro-control should also be in broader sense of attention and response to more generalized price fluctuations.Thirdly,to avoid the possible great negative impact of asset price bust,we should pay more attention on the asset price fluctuations and stabilize the real estate market.Fourthly,monetary policy and other macro-financial policies should advance with the times.Policy development should consider the economy stages and the status of different economic variables.Make the macroeconomic policy under "counter-cyclical" regulation mechanism and enhance the effectiveness and perspectiveness of the policy control.