Rare Combination of High Money Multiplier and Low Excess Reserves Could Signal Economic Recovery for China


A leading analyst says that the rare combination of a record high money multiplier with low excess reserves signals the ongoing recovery of the Chinese economy from the impacts of the Novel Coronavirus.

Multiple cuts to the reserve ratio requirement for Chinese banks have continued to drive the country’s money multiplier to new heights.

The latest data from the Chinese central bank indicates that China’s money multiplier rose to a record high of 7.17 in August, after previously breaching unprecedented heights over the past several months.

Given that the money multiplier is defined as the ratio of commercial bank money (the M2 money supply) to central bank base money, or also as the reciprocal of the reserve ratio requirement, analysts impute the record reading to two key factors:

  1. Multiple reductions by the Chinese central bank of the reserve ratio requirement;
  2. An increase in lending by Chinese commercial banks, channelling excess reserves into the real economy.

According to data from the Peo­ple’s Bank of China (PBOC) as of 15 May the av­er­age statu­tory de­posit re­serve ra­tio for fi­nan­cial in­sti­tu­tions in China was 9.4%, for a de­cline of 5.4 per­cent­age points com­pared to the start of 2018. 

PBOC has im­ple­mented 12 re­serve ra­tio cuts since 2018, re­leas­ing a to­tal of 8 tril­lion yuan in long-term funds by its own es­ti­mate. 

“Reducing the reserve ratio requirement can unleash liquidity, but unleashing liquidity is not the core goal of the reserve ratio requirement cuts,” said Zhou Junzhi (周君芝), macro-analyst from Guangfa Securities, to 21st Century Business Herald.

“The most important function of required reserve cuts is raising the money multiplier, and giving financial institutions room to expand their balance sheets.”

Data from PBOC “Second Quarter Monetary Policy Execution Report” (二季度货币政策执行报告) further indicates that as of the end of June the excess reserve rate of Chinese financial institutions stood at 1.6%, for a decline of 0.4 percentage points compared to the same period last year.

“A low excess reserve rate isn’t rare, and high money multipliers are not unusual,” said Zhou.

“However, for the excess reserve rate to fall to an extremely low level, and the money multiplier to surge to the highest level since data has been publicly announced – this combination can be said to be historically rare.”

According to Zhou this unusual combination means that that large-scale loosening – as embodied by multiple interest rate and reserve ratio cuts by the Chinese central bank, has already past, and the economy is on the road to recovery, with monetary liquidity undergoing marginal tightening.

“In the second half of the year real demand is gradually recovering, and policy is wilfully pulling back on growth in social financing and balance sheet expansion,” said Zhou.

“Under such conditions there will be a large decline in the necessity of reserve ratio cuts, although the money multiplier will continue to remain comparatively high.”

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