(b) Constraints on Banks—the Monetary Base

Monetary Theory
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1. Constraint on cash withdrawing. As the central bank’s liabilities, cash 
is the last resort in the credit monetary system. Clients will require 
banks to turn their own liabilities into the central bank’s liabilities, and 
banks must hold the central bank’s liabilities.
2. Constraint on settlement. Clients will require a bank not only to turn 
its liabilities into the central bank’s liabilities but also the liabilities 
of other banks. Banks cannot exchange their respective liabilities to 
clients and therefore they need to have a commonly accepted asset, 
namely the central bank’s liabilities.
3. Constraint of the required reserve ratio. Only with the first two con-
straints, the central bank still cannot accurately control the credit 
money. When the quantitative relationship between the banks’ liabili-
ties and the central bank’s liabilities is not stable, to stabilize such a 
relationship and to control the amount of the credit money, the central 
bank requires banks to hold a certain proportion of the credit money 
in the central bank’s liabilities. This proportion should be slightly 
higher than or similar to the proportion of the central bank’s liabili-
ties to the credit money held by the bank so that such proportion of 
the bank will be fluctuating around the proportion stipulated by the 
central bank. For central banks that still cannot effectively control the 
total amount of money in an indirect way, this requirement can help 
the central bank to effectively control the aggregate amount of the 
credit money.
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The constraint of the required reserve ratio is different from the first two 
constraints. The first two constraints are about the competition for the mon-
etary base among an individual bank, the public, and the other banks, which 
changes the amount of the monetary base held by the bank. As for the third 
constraint, it establishes a quantitative relationship between the money and 
the monetary base without changing the amount of the monetary base held 
by the bank. If a bank with enough monetary base to fulfill the first two 
requirements has already met the reserve ratio requirement, the bank does 
not need to increase its monetary base, and thus the required reserve require-
ment is no longer a constraint. 
Bank’s creation of credit money is restricted only by these three constraints 
so banks must hold the central bank’s liabilities. The central bank, through 
its own credit behaviors, manages its assets so as to adjust its liabilities that 
would further affect the liabilities of the banking sector. Eventually the cen-
tral bank is able to manage the credit money. For this reason, the part of the 
central bank’s liabilities that plays a restrictive role in bank’s creation of credit 
money is known as the monetary base.
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Controlling the monetary system by 

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Reforms in China’s Monetary Policy
controlling the monetary base is the monetary management principle under 
the credit money system. 
Money is an asset held by the public, serving as media for transactions and 
storing values. The public can exchange money for goods. Banks hold the 
monetary base as an asset, and they exchange this asset with the other banks 
and the public to meet the three requirements and support their operation—
money creation. Therefore the purpose for banks to hold monetary base is 
similar to that of the public to have money. The monetary base rather than 
money is the banks’ “money.”

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