Is There Excess Liquidity in China?

In this paper, we developed the recursive unit root tests proposed by Phillips et al. (2013) and used them to identify the beginning and the end of potential excess liquidity in the Chinese monetary market during the period from 1992 to 2013. The result indicates that excess liquidity existed from the third quarter of 2002 to 2013. The analysis shows that since 2003, the inflationary pressure of excess liquidity has remained high. We provide evidence supporting the money illusion hypothesis in China. The recursive unit root test is suited to practical implementation with time series and delivers a consistent date-stamping strategy for determining the origination and termination of multiple bubbles. Simulations show that the test significantly improves discriminatory power and leads to distinct power gains.