Reforms in China’s Monetary Policy Reforms in China’s Monetary

Monetary Theory
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a stable liquidity management framework. Historically, developed countries 
have mainly lowered the required reserve ratio to reduce the cost burden 
for commercial banks provided liquidity management could be safeguarded. 
Furthermore, in comparing assets-side bond purchase operations with the 
liabilities-side operation of lowering the required reserve ratio, the central 
bank is clearly inclined to expand the scale of its assets. This is mainly because 
the size of the country’s economy and financial assets increase continuously, 
for which the central bank needs to increase its assets to ensure the central 
banks’ assets accounting for an appropriate proportion of the country’s total 
financial assets; otherwise, the central bank’s influence in the economic and 
financial system might be weakened. The structural liquidity deficit created 
by the required reserve ratio enables the central bank to purchase bonds and 
increase its assets. Through the required reserve ratio, the increase of the cen-
tral bank’s assets has an approximate quantitative proportional relationship 
with the increase of deposits and loans in commercial banks. 
Contrary to the common understanding, to increase the same amount 
of excess reserves, the influence exerted by adjusting the required reserve 
ratio is weaker than that of the central bank bond purchases. Lowering the 
required deposit reserves ratio produces positive buffer stock reserves, and 
from the market perspective, funding has increased. In addition, the central 
bank bond purchases reduce the amount of bonds circulating in the market 
when market funding increases and accelerate changes in the bond-to-funds 
ratio in the market. If the central bank purchases 100 billion yuan bonds, the 
influence of such purchase on the market interest rate is greater than that of 
lowering the required reserve ratio to release 100 billion yuan reserves. Due to 
their underdeveloped bond markets, central banks of some developing coun-
tries and emerging countries prefer to use the required reserve ratio; however, 
the effect is usually not good. Monetary policy operations under an indirect 
monetary policy operating framework influence structural adjustments to the 
funds and liabilities of commercial banks mainly through the interest rate 
channel, thus affecting the quantity of money. Therefore, from the interest 
rate perspective, the central bank is inclined to choose assets-side trading.

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