China Raises Bank Reserves in Uphill Fight Against Inflation

http://online.wsj.com/article/SB10001424052748704681904576318892832969946.html?mod=googlenews_wsj


Summary

In order to head off the inflation that hit 5.3% in April, China required its banks to increase their deposit in reserves by 0.5 per cent. Some Chinese economists say that putting pressure on the banks will have variety of unintended consequences. It encourages banks to skirt the requirement by lending money out in different ways that are not covered by the regulations. This act also has negative effects on smaller banks and smaller enterprises. Econommists argue that China needs to help small firms to encourage innovation needed. Banks do not want to increase their interest rates because it would increase the cost of the bonds that the central banks sell, and also the value of Yuan. Raising interest rates could also harm huge state-owned banks due to the investments of big state lenders they invested in securities that are unprofitable.

Connection

Inflation means prices of goods goes up, this is mainly due to the large money supply that flows into the economy. Raising bank reserves is one of the ways to influence the growth of the money supply. When the bank reserves are required to increase to a certain amount, banks have less money to lend out to their customers, thus limiting the money supply flow. When people have less money on their hands, their purchasing powers will decrease. Less money will be flow into industries that are over-heating, and prices of goods will then slowly go down again.

Reflection

I think the reason why China raised bank reserves at this certain time is there will be about one trillion yuan in central bank bills will be mature in Febuary and March. When maturity date of the bills come, a huge money supply will be flow into the economy again. In order to prevent further move in the price of goods, I believed raising the bank reserves is a good decision. However, there is still disadvantages of raising the banks reserves. One of them would be lowering the money supply and decreasing the country's GDP at the same time.