Working Papers

2016-10 | March 2018

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Reserve Requirements and Optimal Chinese Stabilization Policy

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We build a two-sector DSGE model to study reserve requirement adjustments, a frequently-used policy tool for macro-stabilization in China. State-owned enterprises (SOEs) are financed by government-guaranteed bank loans, which are subject to reserve requirements, while private firms rely on unregulated off-balance sheet financing. Increasing reserve requirements reallocates resources to more productive private firms, raising aggregate productivity, but also raises the incidence of SOE bankruptcy. Optimal reserve requirement adjustments are complementary to money supply adjustments for improving macroeconomic stability and welfare. However, welfare gains are greater under sector-specific productivity shocks, which call for resource reallocation, than under aggregate productivity shocks.

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Article Citation

Chang, Chun, Zheng Liu, Mark M. Spiegel, and Jingyi Zhang. 2016. "Reserve Requirements and Optimal Chinese Stabilization Policy," Federal Reserve Bank of San Francisco Working Paper 2016-10. Available at https://doi.org/10.24148/wp2016-10