The Impacts of China's Shadow Banking Credit Creation on the Effectiveness of Monetary Policy

Huiyi Zhang, Richard Skolnik, Yue Han and Jinpei Wu
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Huiyi Zhang: School of Economics and Management, Tianjin University of Science and Technology, Tianjin, China
Richard Skolnik: School of Business, State University of New York at Oswego, Oswego, NY, USA
Yue Han: School of Economics and Management, Tianjin University of Science and Technology, Tianjin, China
Jinpei Wu: School of Business, State University of New York at Oswego, Oswego, NY, USA

International Journal of Finance & Banking Studies, 2020, vol. 9, issue 4, 33-46

Abstract: This paper researches the impact that shadow banking in China has upon credit creation and the potential effectiveness of monetary policy. Using a credit creation model, we derive the effect that shadow banking has upon the money multiplier and the money supply. The model shows that shadow banking can change the money multiplier, potentially increasing it during an expansion and decreasing it during a contraction. Introducing shadow banking in a CC-LM model results in a shift of the CC and LM curves resulting in a higher equilibrium output. A vector autoregressive model is used to empirically estimate the impact of shadow banking deposits' growth rate on the growth rates of the broad money supply, GDP, and the CPI. The results show that shadow banking's credit creation function in China has a pro-cyclical characteristic, potentially reducing the money supply's controllability and increasing the difficulty in effectively regulating monetary policy. This paper introduces shadow banking into the currency creationprocess of traditional commercial banks, accounting for the reserve requirement ratio, the excess reserve ratio, the shadow bank leakage rate, and the reserved deduction rate. Future research can determine whether coordinating monetary policy and leverageratio regulation mitigates the impact of shadow banking. Another area of research is how the shadow banking of non-financial companies affect monetary policy.

Keywords: Shadow banking; Credit creation; Monetary policy; CC-LM model; VAR model (search for similar items in EconPapers)
Date: 2020
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