ANALYSIS ON DETERMINANTS OF CHINA'S MONEY MULTIPLIER

Under the modern banking system, the basic model of money supply shows that the size of money supply size is decided not only by base money, but also by the money multiplier. The central bank's ability to control the money multiplier is limited compared to base money, as the multiplier is influenced by such factors as depositors' cash holding and liquidity changes in the banking system. An understanding of laws governing changes in the money multiplier, therefore, benefits the central bank's moderate implementation of monetary policy to fulfill its monetary policy goals.

Since 1995, China's money multiplier has generally exhibited an upward trend. Due to a series of important financial reforms launched by the central bank in 1998, which have impacted, either directly or indirectly, the country's money multiplier and base money, the relationship among money multiplier, base money and money supply underwent a dramatic transformation around 1998: before the first half of 1998, the growth of money supply was mainly influenced by base money and the multiplier had basically remained stable; subsequently, both of their relationships to the money supply changed. In the latter period, the money multiplier was unstable and hard to control. Furthermore, the multiplier and base money followed inverse paths. When the central bank increased base money, the money multiplier went down, thus making the growth of money supply indistinctive-while the converse was true. All of these developments presented great challenges for monetary policy after the first half of 1998.

In currency banking studies, determinants of the money multiplier include the withdrawal ratio, excessive-reserve ratio, required-reserve ratio, and other deposit ratios. Given the constancy of the required reserve ratio, the withdrawal ratio and excessive reserve ratios are major influences on the money multiplier. China's withdrawal ratio primarily shows a declining trend. However, seasonal movement is easy to identify during a year. Consequently, the impact from withdrawal ratio on money multiplier is mainly embodied in such seasonal changes. Changes in the excessive-reserve ratio, therefore, are the key influence on money multiplier movement. Adjusted for seasonal factors, the excessive-reserve ratio, although showing a general declining trend, is still fairly high and subject to large fluctuations. Major reasons for this include: problems exist in commercial bank liquidity management; liquidity in China's money market has yet to be improved; and China's high deposit ratio, simplified financial asset structure and interest-bearing reserve system lead to commercial banks being willing and able to maintain excessive reserves. We estimate that 3 percent is the lowest excessive reserve level in current China. Although higher than that in foreign financial institutions, this figure is reasonable when considering China's situation.

To sum up, we may arrive at the following conclusions. First, the abundance of excessive reserves influences the effects and efficiency of monetary policy transmission, and the excessive-reserve ratio, in many cases, fails to accurately capture commercial banks' liquidity. Second, raising required-reserve ratios and issuing central bank papers with maturities over one year can reduce the impact of financial institutions' excessive reserves, thus constituting a significant tool for the central bank's adjustment. Third, the influence of the withdrawal ratio on the multiplier is mainly manifested in seasonal factor impacts. As a result, commercial banks should make reasonable estimates about seasonal liquidity demands and the central bank should grant proper liquidity support. Fourth, a high level of liquidity have to be maintained in commercial banks, taking into consideration the level of liquidity management in China's commercial banks, the status quo of China's money market, clearing and settlement efficiency, electronic equipment condition, and the multi-level management system of branches and sub-branches in China's state-owned commercial banks. However, even if the excessive reserves of financial institutions could be absorbed by the central bank, the excessive reserve ratio is still high compared to developed countries.