The demand for money in China 1987-2004: A non-linear modelling approach

This paper investigates non-linearities in the demand for money in China that would suggest a threshold point for inflation materially entering into the decisions of Chinese households and firms. This is achieved by adopting Terasvirta's [Terasvirta, T. (1998). Modelling economic relationships with smooth transition regressions. In: Ullah, A., & Giles, D. E. (eds.), Handbook of applied economic statistics, chapter 15, pp 507-552. New York, Marcel Dekker, Terasvirta, T. (2004). Smooth transition regression modeling. In: Lutkepohl, H., & Kratzig, M. (eds.), Applied time series econometrics, chapter 6, pp 222-242. Cambridge, Cambridge University Press] procedure to test the linearity of an error correction model of money demand against a smooth transition regression (STR) non-linear alternative. It finds there is a critical threshold figure for inflation affecting real money demand in China, at about 5%. The high and low inflation regimes are quite different from each other, so that non-linearity in the model is strong.