Document Type

Paper Series

Publication Date

2005

No.

163

Abstract

The Chinese economy experienced both a historical double-digit inflation in the mid-90s and unprecedented deflation in the late 1990s and early 2000s. The People's Bank of China, which is the Central Bank of China, has been trying to adopt an active monetary policy to reduce inflation and contain deflation. However, there remains an open issue whether its policy is effective. We formally investigate the effectiveness monetary variables in the two regimes of inflation and deflation, respectively, via the vector auto-regressive (VAR) models. One of the biggest challenges to our research is the frequent structural changes in the Chinese monetary system. This implies that both the lags and the parameters of the VAR model are not constant over time. Therefore we apply the surplus lag rolling estimation to conduct our Granger causality tests from money to price. The main findings of this paper are that the monetary variables have become less effective to the price level in the deflation era started from 1998. This conclusion is consistent with the recent development of the neo- Keynesian macroeconomic model which predicts that the monetary expansion is less effective in an environment of deflation. It also provides some empirical evidence to support the Chinese government to adopt alternative policies such as an active fiscal policy for the purpose of demand management in the era of deflation.

Comments

CPPS Working Paper Series No.163 (Dec 05)

Recommended Citation

Ma, Y., & Sun, H. (2005). Money stock, price level and structural changes in the transitional economy of China (CPPS Working Paper Series No.163). Retrieved from Lingnan University website: http://commons.ln.edu.hk/cppswp/75/

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