This thesis studies how the central bank sets the reserve requirement ratio in China. The monthly series of reserve requirement ratio and inflation data from January 1999 to May 2011 are used to examine both the long-run relationship and the short-run dynamics between changes in reserve requirement ratio and inflation pressure. Our results show that there is a quite weak long-term relationship between reserve requirement ratio and inflation, reflecting the fact that as a tool of monetary policy, reserve requirement ratio is rather ineffective in China. This may be attributed to the macro-economic regulatory objective of keeping the currency at a relative stable level, stimulating economic growth and creating more job opportunities. In the short-run, the reserve requirement ratios of both large and complex financial institutions and small and medium financial institutions respond somewhat to inflation pressures, and changes in inflation has a greater influence on changes in reserve requirement ratio for small and medium financial institutions than that for large and complex financial institutions. However, the extent of disequilibrium at time (t-1) has little effect on reserve requirement ratio.