Chinese monetary policy and the banking system

Abstract

Chinese monetary policy differs from that of many other countries in its use of multiple policy instruments. This paper assesses the effectiveness of some of the instruments employed, using a model of the banking sector and elasticities estimated from Chinese data. We find that direct interest rate changes are a poorer instrument of monetary control in China than changes in reserve requirement ratios and loan-to-deposit ratios. This finding is based on the ambiguous estimated response of deposit demand to such changes, and may help to explain why changes to administered interest rates have been used sparingly as an instrument of Chinese monetary policy. We also find that the ambiguous deposit demand response could pose challenges for the effectiveness of open market operations under interest rate liberalisation, while exchange rate liberalisation is likely to make monetary instruments more powerful.