There has been a number of different hypotheses regarding the causal relationship. The quantity theory of money posits that money is determined exogenously. Cagan (1965) argues that money supply presents both endogenous and exogenous properties. For short-run and cyclical fluctuation, Cagan (1965) proposed a relation in which the money supply is endogenously determined by changes in the real sector. In the monetarist view an increase in the money supply, may lead to an increase in output in the short-run, however in the long-run it may only impact prices. Monetarists abandon the existence of a long-run Phillips curve trade-off, while allowing for the possibility of a short-run trade-off as expectations adjust. Nominal rigidities models by incorporating rational expectations had shown that monetary shocks do have real effects (Fischer, (1977), Phelps and Taylor, (1977), Taylor, (1979)). The monetarist position implies a short-run trade-off between real and nominal magnitudes, with money supply impacting prices alone in the long-run. The rational expectations school would rule out short-run as well as long-run causality from anticipated money supply to output. The different Keynesian models, emphasising rigidities, lead to theoretical short-run or short-run as well as long-run causation from money supply to output depending upon whether the structural rigidities are short-term or long-term. Which of these positions best describes the Chinese context can only be determined by an empirical methodology that is capable of distinguishing between causality in the short-run and the long-run. The commonly used time domain methodologies of determining direction and strength of causality do not decompose causality by different time horizons. This weakness constitutes a limitation on the empirical understanding of the money-income and money-prices causality in the Chinese context. Given this background my study intends to investigate the money and output and money and price causality.
Start date:October 2015
Research Topic:Causality Between Output, Prices and Currency in China
Research Supervisor:Professor Patrick Minford
Supervising school:Cardiff Business School, Cardiff University
Primary funding source:ESRC Studentship