From the WSJ MarketWatch:

China cuts banks' reserve ratio

Published: Apr 19, 2015 9:45 a.m. ET By
LINGLING WEI, Mark Magnier contributed to this article.

BEIJING–China's
central bank reduced the amount of reserves commercial banks are required to
hold, freeing up about $200 billion for lending in the latest easing measure to
shore up the world's second-largest economy.

The People's Bank
of China's one percentage point cut in the reserve requirement, announced
Sunday, is a larger-than-usual reduction. It is the second cut in banks'
reserve requirement in less than three months and comes after the economy
decelerated to 7% year-over-year growth in the first quarter, the slowest pace
in six years.

China has been struggling with economic ills, ranging from a
slumping property market and persistent industrial overcapacity to high debt
levels among companies and local governments. Many Chinese officials and
economists say the central bank will have to step on the easing pedal harder
for Beijing to
reach its 7% annual growth target for this year–already the lowest level in 24
years.

The government has
been trying to guide the economy to a soft landing. But the latest step
highlights concerns growth continues to flag and that two interest-rate cuts
since November and other easing measures helped heavily indebted industries and
fueled a run-up in the stock markets, but failed to lift areas that nurture
demand and consumption, such as small businesses. Borrowing costs for business
remain high, made worse by weak prices that border on disinflation.

Still, China's central
bank officials remain wary of too much easing, for fear that relaxing credit
too aggressively would add to the country's debt problems and put the economy
at greater risk. In a statement at the International Monetary Fund's meetings
in Washington this weekend, the People's Bank
governor, Zhou Xiaochuan, said that while China's economic growth is slowing,
it's still within a "reasonable range" and employment growth remains
stable. Mr. Zhou reiterated that China will maintain a
"prudent" monetary policy stance.

Sunday's announced
cut, which lowers the reserve-requirement ratio, or RRR, to 18.5%, takes effect
Monday. The move frees up about 1.2 trillion Chinese yuan (US$194 billion) in
additional funds that banks can now lend. The central bank also announced additional
reserve reductions aimed at banks catering to agriculture and small businesses,
which some analysts say will free up an additional 300 billion yuan in funds.

A question now is
whether Chinese banks and companies will take advantage of these new efforts or
hold fast amid further signs of slowing growth.

Despite prodding
from policy makers, Chinese banks have become increasingly cautious about
making loans, especially to small and private businesses, which are generally
seen as higher credit risks than big state-owned companies–the state banking
sector's mainstay customers. On Friday, China's Premier Li Keqiang urged banks
to step up their support to the economy, saying that the government would give
commercial banks "preferential policies" if they lend to small
borrowers.

The latest
reserve-requirement cut was unusually large in scale. The central bank last cut
the required reserves in early Feb.–the first such move since May 2012–by the
typical half a percentage point.

In the past, the
central bank used the reserve requirement to counteract cross-border capital
inflows, hiking the ratio banks were required to hold to sop up money investors
were pouring into China
to capitalize on the red-hot economy. Now, with the Chinese economy cooling,
there are increased signs of money leaving China's shores. Yuan positions on
the central bank's balance sheet, a gauge of capital flows, declined a record
251.1 billion yuan in the first quarter. With the outflows come higher
expectations for more reserve cuts.

"China should cut the RRR 20 times in the next
five years as the pattern of capital flows has changed significantly,"
said China
economist Larry Hu at Macquarie Group Ltd

Fan Gang, professor of economics at Beijing University, explains the need for Chinese sterilization. Here is the abstract: 

While the Fed is pumping more money into the US economy, the
People’s Bank of China (PBC) is trying to reduce the amount of money in
circulation. Money used by commercial banks to satisfy the required reserve
requirement (RRR), which is held in accounts at the PBC, can no longer be
extended as loans. As a result, more money than ever is now frozen or inactive
in China. 

It is understandable that the Fed wants to boost demand as long as the US economy
remains depressed. But why has the PBC tightened monetary policy so much? Inflation
is a concern – having risen to 4.4% year on year in October, from 3.6% in
September. But really, the PBC’s policy is preemptive: sterilize over-liquidity
and get the money supply under control in order to prevent inflation or
over-heating.

At the beginning of the year, the RRR increases could be regarded
as part of efforts to correct the over-supply of money that arose from the
anti-crisis stimulus package. But the most recent RRR increases serve mainly to
sterilize the increase in the money supply caused by the increase in
foreign-exchange reserves.

Indeed, in September 2014 alone, China’s foreign-currency reserves
increased by almost $100 billion compared to August. With the global economy
recovering, China’s
trade surplus began to grow. The rapid growth in foreign-exchange reserves, means
an increase in the domestic money supply, because the PBC issues RMB6.64 (down
3% since June) for every dollar it receives. That means that money supply
increase by nearly RMB700 billion in September. The two 50-basis-point RRR
increases just locked up the same amount of liquidity. The PBC now holds more
than $2.6 trillion in foreign reserves.

The RRR is only one example of a textbook sterilization
instrument. Another is to sell off government bonds held by the central bank in
order to take money out of circulation – again, just the opposite of what the
Fed is now doing. But the PBC sold out its holdings of Chinese government bonds
in 2005. So it had to create something else to sell. It created so-called
“Central Bank Bills,” which commercial banks are supposed to buy voluntarily.
When they do, the money they pay is also locked up in the PBC’s accounts. To
date, up to 5-6% of total liquidity has been returned to the central bank in
this way.

Roughly one-quarter of China’s total monetary base is
illiquid [tied up in RRR]. Thus, although China’s total money supply seems
excessive, with the M2-to-GDP ratio now at about 190%, the real monetary base
is actually much smaller than it appears. As a result, China’s
inflation, as well as asset prices, remain under control. With the Fed’s QE2 on
the table, conditions may worsen before they improve. The PBC may have to
continue its sterilization for some time in the foreseeable future. 

The Romer and Romer corollary to This Time It Different 

Austan D. Goolsbee and Alan B. Krueger both had front row seats at the time… 

Can long-term global growth be saved?

neglects the aggregate vs per capita growth destinction. But gets to the point of Chad Jones' "Upcoming Slowdown in U.S. Economic Growth" just with the exact opposite answer (Jones' update of sorts of the earlier paper is here and here). Robert Gordon made a similar point recently. 

Where to look for global growth?

is sobering