The causalities running from money and monetary policy to asset prices were brought to the fore by the experience of the recent Global Financial Crisis. Our specific interest in investigating these chains of causality in the case of China is motivated by three considerations. Firstly, no previous study has examined these chains of causality in China even though it is now the world's second largest economy. Secondly, the rapid growth of monetary aggregates is routinely cited by commentators as a cause of asset price inflation in China, but this assertion is usually only based on anecdotal evidence. Thirdly, different institutional conditions in China suggest that the impacts of money and monetary policy on asset prices may be different from that in other countries.
By using a structural vector auto-regression model with short run restrictions, we find little evidence to suggest that monetary policy shocks have a significant impact on asset prices in the case of China. A simulated out-of-sample forecasting methodology is also used to assess the strength of the broader causality running from money to asset prices. The results show that the growth of money and the level of the short-term interest rate have no significant impact on asset price inflation. While our results are contrary to previous findings in the case of developed countries such as the US, they are not entirely surprising in the case of China given only partial interest rate liberalization and incomplete financial markets. Our findings suggest that the actions of the People's Bank of China are unlikely to have significantly contributed to asset price inflation, and in similar vein, that China should not (and cannot) rely on monetary policy as a tool for stabilizing asset prices.