Optimal Monetary Policy in China with Money as Not Redundant

• Author: Guoxiong Zhang
• DOI: http://doi.org/10.1111/1467-8462.12323
• Published date: 01 September 2019
• Date: 01 September 2019

Optimal Monetary Policy in China with Money as Not

Redundant

Guoxiong Zhang

Abstract

This article provides three pieces of evidence to

show that money is not redundant in China:

aggregate real money balance can affect

aggregate demand even when its effect through

short-term interest rates is controlled. I

estimate a DSGE model using Chinese data.

With the estimated model, I find that monetary

policy that controls the money supply (the

quantity rule) is better than the one that

controls the short-term interest rate (the price

rule) in terms of minimising welfare loss. I then

discuss the optimal monetary policy that

combines both the price rule and the quantity

rule.

Monetary policy without money is so widely accepted that

it now appears in pedagogical writings at the undergradu-

ate and graduate levels (Romer (2000), Stiglitz and Walsh

(2000), and Woodford (2002)).

[Leeper and Roush 2003]

1. Introduction

Money has long disappeared from modern

monetary policy analysis. In ad dition to

Leeper and Roush (2003) who are quot ed

above, many other studies including Lucas

and Nicolini (2015), Nelson (2002), Ireland

(2004), Belongia and Irelan d (2015) and

Belongia and Ireland (2016) ha ve also noticed

this trend and call for more resear ch on the

role of monetary aggregate s in monetary

policy analysis. In most dyn amic general

equilibrium monetary models (New Keynes-

ian or Classical), money is re dundant: money

balance does not enter the IS equation or the

Philips curve. In other wor ds, money balance

itself affects neither aggreg ate income nor the

trade-off between aggrega te income and

inflation. In reality, howev er, many studies

(Friedman and Schwartz 1963; Koe nig 1990;

Nelson 2002; Leeper and Roush 2003;

Belongia and Ireland 2015; Belo ngia and

Ireland 2016) find that money is not redun-

dant: real money balance can affect aggr egate

demand even if its effect on short-term

interest rates is controlled.

1

The redundancy of money balance may not

be practically important in the United States.

This is because the Federal Reserve’s monetary

policy has been targeting the interest rate, the

so-called price rule, for a very long time. Even

* Zhang: Antai College of Economics and Management,

Shanghai Jiao Tong University, Huashan Road 1954,

Xuhui District, Shanghai 200030, P.R. China. Email:

<guoxiong@sjtu.edu.cn>. I thank the Editor Ross

Williams, the anonymous referee and participants at the

2017 China Meeting of the Econometric Society for their

valuable suggestions. Financial support for this research

from the new faculty start-up grant of Shanghai Jiao Tong

University and the National Science Foundation of China

(Grant No. 71403168) are also gratefully acknowledged.

All errors are my own.

The Australian Economic Review DOI: 10.1111/1467-8462.12323

°

C2019 The University of Melbourne, Melbourne Institute: Applied Economic & Social Research,

Faculty of Business and Economics

Published by John Wiley & Sons Australia, Ltd

The Australian Economic Review, vol. 52, no. 3, pp. 294–304