To try to help reduce inflation, the People’s Bank of China (the central bank of China) has ordered banks to hold a greater proportion of their assets as cash. These higher reserve requirements will limit the ability of the banks to create deposits and is a form of monetary policy intended to support the fight against inflation. However, how successful is this likely to be given the rapid economic growth being experienced by China?
China lifts reserve requirements for banks Times Online (12/5/08)
Questions
| 1. | Explain how a higher reserve requirements helps reduce inflation. |
| 2. | Evaluate two policies that the central bank could adopt, other than raising reserve requirements to help control inflation in China. |
| 3. | “As underlying inflationary pressures remain undiminished, it is vital for the government to keep its tightening policy stance to anchor inflationary expectations.” Discuss the extent to which a tightening policy stance will influence inflationary and other expectations. |