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Two-Stage Dynamic Test of The Determinants of the Long-Run Decline of China's Monetary Velocity

The Engle-Granger two-step method is used to test the determinants of the long-run decline of China's monetary velocity based on two stages (1978-1992 and 1993-2008). High growth of household savings and economic monetization have significant effects on monetary velocity, but interest rates and inflation rates do not. Foreign exchange reserves did not significantly affect monetary velocity in the period 1978-1992, but were significant from 1993 to 2008. The high growth in household savings, economic monetization, and amount of foreign exchange reserves had a greater effect in the second period than the first, earlier period. This was most likely due to the rapid increase in household precautionary savings, the quick monetization of factor markets, and the growing effect of funds outstanding for foreign exchange on the monetary base since 1993. The long-term decline of monetary velocity reflects a number of underlying problems. Steps must be taken to guarantee the long-term health and financial development of the Chinese economy.