Reserve Requirement Policy, Bond Market, and Transmission Effect

Li Ma, Tsangyao Chang and Chien-Chiang Lee ()
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Li Ma: Department of Finance, Wuhan University, Wuhan, China

Journal for Economic Forecasting, 2016, issue 2, 66-85

Abstract: The adjustment of the reserve requirement ratio is one of the most frequently used monetary policy instruments employed by monetary authorities in emerging market economies. According to monetary theories, it was primarily designed to influence the monetary multiplier. However, both academics and practitioners have long questioned whether such a requirement has an impact on commercial bank bond holdings and the output of real economy through price fluctuations in the bond market. In this paper, we set up a macroeconomic equilibrium model that includes central banks, commercial banks, and enterprises, covering a wide range of credit markets, bond markets, and commodity markets. In order to explore the transmission effect of the reserve requirement ratio policy through the bond market, we introduced the method of limit solutions using non-homogeneous linear differential equations with constant coefficients. We empirically examine the existence and effectiveness of transmission mechanisms by applying the TRAMO technique and a cointegration test based on large- sample data from China. The results show that the adjustment of the reserve requirement ratio affects the asset structure of commercial banks, bond market prices, and ultimately the real economy.

Keywords: reserve requirement ratio; bond market; transmission effect; monetary policy (search for similar items in EconPapers)
JEL-codes: E42 E52 E58 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (1)

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