Chun Chang and Jingyi Zhang, Shanghai Jiao Tong University, and Zheng Liu and Mark Spiegel, Federal Reserve Bank of San Francisco


Reserve Requirements and Optimal Chinese Stabilization Policy
 

Chang, Liu, Spiegel, and Zhang build a two-sector DSGE model of the Chinese economy to study the role of reserve requirement (RR) policy for capital realloation and business cycle stabilizaton. In the model, state-owned enterprises (SOEs) have lower average productivity than private firms, but they have superior access to bank loans because of government guarantees. Private firms rely on "shadow" bank financing. Commercial banks are subject to RR regulations but shadow banks are not. The researchers' framework implies a tradeoff for RR policy: Increasing RR acts as a tax on SOE activity and reallocates resources to private firms, raising aggregate productivity. This reallocation is supported by empirical evidence. However, raising RR also increases the incidence of costly SOE failures. Under their calibration, RR policy can be complementary to interest-rate policy and useful for stabilizing macro fluctuations and improving welfare.