China’s Monetary Sterilization

Not long after the US Federal Reserve announced its second round of “quantitative easing, China’s central bank announced another two large increases in the required reserve ratio for bank deposits. How much more of this monetary tightening can China's commercial banks take?

BEIJING – Not long after the United States Federal Reserve Board announced its second round of “quantitative easing” (known as QE2), the People’s Bank of China (PBC), China’s central bank, announced two increases of 0.5 percentage points in the required reserve ratio (RRR) of bank deposits. The RRR now stands at 18.5%, a historic high, even in global terms.

While the Fed is planning to pump more money into the US economy, the PBC is trying to reduce the amount of money in circulation in China. Money used by commercial banks to satisfy the RRR, which is held in accounts at the PBC, can no longer be extended as loans. As a result, more money than ever is now frozen or inactive in China.

It is understandable that the Fed wants to boost demand as long as the US economy remains depressed. But why has the PBC tightened monetary policy so much? The Chinese economy is not over-heating. Growth is still high, at about 10% per year, but has started to moderate. And, while inflation is a concern – having risen to 4.4% year on year in October, from 3.6% in September – this cannot explain why the PBC raised the RRR three times earlier this year, when inflation was lower.