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Measuring substitution in China's monetary-assets demand system

Man Jin

China Economic Review, 2018, vol. 50, issue C, 117-132

Abstract: This paper examines China's money demand using a Normalized Quadratic function in the search for global flexibility and easing of the degree of freedom. I impose the theoretical regularity conditions in the model that much of the previous literature ignores. I provide the robust estimates of the Morishima elasticities of substitution among currency, demand deposits and time deposits. I find that currency and demand deposits are elastic substitutes in use, while time deposits are inelastic substitutes with the former two. Time deposits are distant from a medium of exchange, and agents treat them as a saving asset, separable from the composite of currency and demand deposits. The results imply that the narrow money M1 is well-defined, while the broad money M2, which assumes perfect substitution of the component assets, is problematic. A monetary aggregate that internalizes the substitution effects should be adopted in China.

Keywords: Elasticity of substitution; Monetary aggregate; Normalized quadratic functional form; Regularity condition (search for similar items in EconPapers)
JEL-codes: C3 E41 E50 G21 O5 (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1016/j.chieco.2018.04.003

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China Economic Review is currently edited by B.M. Fleisher, K. X. D. Huang, M.E. Lovely, Y. Wen, X. Zhang and X. Zhu

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