China Excess Liquidity Causes And Countermeasures

Excess liquidity is the primary problem of China's macroeconomic growth picture, affecting multiple facets of the economic fabric and creating a dilemma for macroeconomic policy management. Eliminating the excess liquidity is thus the focus of government policy initiatives. This paper seeks to examine the root of this excess liquidity from both theoretical and empirical bases, drawing at large from the schools of thought in present economic literature. Findings suggest that strong savings and excessive capital inflow is the culprit in a virtuous (vicious) cycle of spiralling real and financial asset inflation. So far, the official policy response has been to impose monetary tightening by increasing reserve requirements and imposing more stringent lending ratios on the financial institutions in a series of hawkish moves. Reducing the large fiscal deficit has also been a policy move with the view of private consumption expenditure eventually picking up the slack of reduced public sector spending to provide the a cushion for the harmful growth effects of the deflationary measures. In the intermediate stage much needs to be done to remove present foreign exchange controls to allow a flexible exchange rate to act as an additional agent of restoring economic balance by equilibrating to accommodate an appropriate level of foreign capital inflows. For now however,a proper balance in the level of unremunerated reserve requiements needs to be maintained to ensure that the appropriate spread between domestic and external returns remains commensurate to restore macroeconomic balance and providing greater manouvreability for monetary policy.Nonetheless, as both fiscal and exchange rate policy controls represent structural reforms of entrenched policy regimes for China, monetary policy remains the immediate policy tool for curbing this excess liquidity.