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Reserve Requirements and Optimal Chinese Stabilization Policy
April 6, 2016Macro, Trade, and Finance Seminar Series

Speaker: Zheng Liu is a Senior Research Advisor at Federal Reserve Bank of San Francisco. More »

Abstract: China’s central bank frequently uses reserve requirements as a policy instrument, in contrast to advanced economies which mainly adjust interest rates. We argue that the use of reserve requirements can be effective as a second-best policy for macroeconomic stabilization given the distortions in China’s existing financial system. In China, state-owned enterprises (SOEs), although on average less productive, enjoy superior access to bank loans, while private firms rely more heavily on non-banking intermediaries, or the “shadow banking” sector to obtain credit. Formal banks differ from shadow banks in that they enjoy implicit lending guarantees, but are subject to reserve requirements. We build a two-sector DSGE model that captures these Chinese characteristics and find that adjusting reserve requirements involves a tradeoff between allocation efficiency and social cost of SOE firm failures. A higher required reserve ratio raises the relative funding costs for SOE firms, reallocating resources towards the private sector and improving aggregate productivity. However, the incidence of costly firm failures also increases. Under our calibration, there is an interior optimum for the required reserve ratio that maximizes social welfare in the steady state. Over the business cycles, adjusting reserve requirements is complementary to interest-rate policy. The two policy instruments, if chosen optimally, can achieve superior outcomes for macroeconomic stability and welfare relative to the standard Taylor rule.

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*This is a joint event with IMF.

Last Updated: Apr 04, 2016

The Macro, Trade, and Finance Seminar Series is a weekly series hosted by the World Bank's research department. The series invites leading researchers from the fields of macroeconomics, growth, trade, international integration, and finance to present the results of their most recent research in a seminar format. The full list of seminars can be viewed here.

Last Updated: Jul 27, 2015

Event Details
  • Date: April 6, 2016
  • Location: IMF HQ1 10-713
  • Time: 12:00 – 1:30 pm
  • CONTACT: Shweta Mesipam
  • smesipam@worldbank.org

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