The Characterristics Of China’s Money Supply In The Open Economy

In retrospect of China’s economic and financial situation since years ago, we findthat for the period2006-2007excessive liquidity had heated the macro-economy andcaused inflation, while for the period2009-2010unconventional money supply hadspurred the economy rebound. Money supply was the dominant factor behind this,and at the same time, the central bank’s monetary policy faced many disputes. China’smonetary authority, the People’s Bank of China, has set money supply as theintermediate target. In consideration of this, money supply has lately attracted widespread interest in the academic circles. As a transitional economy, China haswitnessed great change from planned economy to market economy, therefore due tolong-term restrictions of structural and institutional obstacles, development strategiesand open-up policy, China’s money supply has its distinctive characteristics of times.On one hand, policy makers have to make tradeoffs between transforming theeconomic development pattern with short-term pains in economic slowdown, andfollowing the old routine of pouring liquidity to spur economy. On the other hand,with the speed-up of RMB capital account liberalization, there shall be morecomplicated factors influencing China’s monetary policy. Thus, it matters a lot toresearch on China’s monetary base supply both from theoretical and practical aspects.When it comes to the organization of this thesis, it extends as follow. Chapterone gives a systematic review about money base supply and the McCallum rule. Inchapter two, this thesis summarizes China’s money base supply mechanisms fromfour perspectives as measurability, controllability, endogeneity and correlation, thenbased on its correlation with output growth, inflation rate, foreign reserve and RMBexchange rate each, it pre-establishes the McCallum rule as the theoretical framework.After a comprehensive retrospect on the research development of the McCallum rule,chapter three comes up with a modified version of McCallum rule which fits wellwith China’s economy. Chapter four is empirical study. It proves the existence of aunidirectional causality from output growth, inflation rate, foreign reserve and RMBexchange rate each to money base supply. In order to dynamically trace the changepath of individual factor’s effect on money base supply, this thesis establishes a statespace model and estimates it using Kalman filtering on China’s time series from1994to the first quarter of2012. This contributes to identify the main factor influencingChina’s money base supply and clarify its certain characteristics.It finds that in the practice of money base supply, the central bank gives too much focus on maintaining economic growth, while inflation pressure inefficientlyserves as a restriction against uncontrollable money supply. Foreign reserve is foundto be the central factor affecting money base supply, whose traction otherwise causeobvious endogeneity and passiveness in China’s money supply. Under the influence ofhigh-speed growth addiction and increasing foreign reserve, the central bank’sinitiatives and freedom in formulating monetary policy has been seriously compressed,then it cannot help but face the dilemma of contraction between different objects.Based on the conclusions above, this thesis, in the end, suggest that firstly it’snecessary and timely to change the mode of economic growth and rectify themisleading "money supply-economic growth" philosophy. Besides, it’s urgent tospeed up the monetary market construction and enrich write-off intervention tools toperfect the open market operation. Last but not least, it’s beneficial to propel interestrate marketization reform, as to gradually perfect the conditions for establishinginterest rate as the intermediate monetary policy target.