Central Bank Deposit Requirements and the Chinese Term Paper

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Central Bank Deposit Requirements and the Chinese Economy

China's announcement that its central banks need to hold more deposits will effect the balance sheets of both the central and commercial banks quite strikingly. In order to preserve the current value of its currency, the central banks are manipulating the required deposits in order for the banks to have more cash on hand. The higher deposit rates will reflect positively upon the analyses of the countries' central banks because it will show a much higher level of capital available for both internal investment and lending. In effect, the banks' reserves ("R") are tools that can be used to further manipulate the financial sector of the Chinese economy as well as the interest rates and currency strength. This occurs through increased reserve requirements, which helps to stem the possibility of inflation by keeping the banks' assets and capital locked up and illiquid (McConnell, Brue, and Flynn, 2008).

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This increased capital in turn influences the balance sheets in a way that suggests the Chinese economy is stronger than it would have been had it not made the announcement. During the global economic recession, every major economy in the world was looking to offload toxic and unappreciative assets from their central and commercial banks' books. China has been able do this in a way that both helps its own economy and helps to secure the de-valued currency that has helped prop the economy up for over a decade. The effects of such a requirement are also indicative of a government that wants to have more power over the money supply. Since the United States has been printing trillions of dollars in its attempts at quantitative easing, the Chinese are fearful that interest rates may not be entirely effective at stopping widespread inflation in the money supply. The accepted influence of "R" on the money supply is quite clear, and is a function of other factors such as the monetary base (Mb), monetary supply (MS), the savings rate (percentage above or below 100) of the country's citizens (c), and the money multiplier (mm). Mathematically, this can be represented in the following formula:

MS = Mb x mm whereas mm = (1+c)/(c+R)

Term Paper on Central Bank Deposit Requirements and the Chinese Assignment

By demanding higher deposits levels, the Chinese government is exacting more influence over the end product, the money supply (MS) (McConnell, Brue, and Flynn, 2008).

The economic impact of the Chinese Central Bank's decision to require more deposits is quite clear and is best understood as a potential influence on the country's overall economic health and position within the world's economic system. The potential impact on GDP could be quite convoluted, since the Chinese government is bent on keeping the current value of its currency devalued. However, a clearer picture of the influence on GDP emerges when both aggregate and equilibrium expenses and their effects on GDP are considered. First of all, by tightening the country's money supply (MS), the Central Bank is helping to keep interest rates low. The greater the MS, the higher interest rates tend to move since the higher MS value tends to lead to inflation (McConnell, Brue, and Flynn, 2008). The Central Bank's announcement is well timed to help prevent inflation in the near to medium term for the Chinese economy. This will positively affect its GDP since it will help keep the currency devalued and the trade imbalances intact. The Chinese GDP depends largely on its currency valuation.

The future demand or future GDP numbers are predicted within the aggregate expense function. If the cost of borrowing money is higher (higher interest rates and inflated economy), the Chinese economy (GDP) will likely grow more slowly. This is because as firms and businesses demand loans and credit to grow, there is less and less motivation to borrow at higher interest rates (McConnell, Brue, and Flynn, 2008). By keeping rates low, firms and businesses, which impact production and GDP are more likely to borrow money to grow and expand, all the while the Central Bank has a higher reserve (R) to keep liquidity outside of the banks and within the general, GDP producing economy under control as well. This is another way to help control inflation. Since the future cost of borrowing (aggregate demand) is in effect lowered, or kept artificially attractive to Chinese businesses, internal growth and GDP output is positively influenced (McConnell, Brue, and Flynn,… [END OF PREVIEW] . . . READ MORE

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