When worries of inflation arise, what should government do?

By Yi Xianrong
0 CommentsPrint E-mail China.org.cn, November 6, 2009
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Before the government tries to manage inflation concerns, the paramount task on the table is to design a scientific inflation measurement. After that, the government has to clarify how inflation forms.

The Consumer Price Index (CPI) and Producer Price Index (PPI) are two widely used measures of inflation in China. CPI is more important than PPI as a gauge of inflation. In my opinion, China's CPI system has much to be desired because it cannot adapt to the current economic situation. The system has undergone very few changes since it was established in 1993. If the CPI system has flaws in itself, it is impossible to spot the trend in inflation correctly.

The concerns regarding inflation are raised by the government's 4 trillion yuan stimulus package, with more than 8 trillion loans flowing from the banks. According to the traditional monetary theory, excessive money supply ordinarily runs the risk of fueling inflation.

Yet, over the last two or three decades, the formation of inflation has undergone fundamental changes. Although inflation is a factor that influences monetary policy in its right, a loose monetary policy doesn't necessarily cause inflation. For example, Japan has adopted a near-zero interest rate since its asset price bubble burst in the early 1990s. However, instead of rising, prices there have actually fallen.

China is different from Japan. China's financial market is connected with the global market, yet its capital account hasn't been totally freed-up. So the free equity naturally chasing profit will flow into the global market through "grey channels." The other scenario is that when the economic situation is still uncertain, money will pour into stock and the real estate market for value preservation or speculation. The recent surge in shares and properties is partly a result of massive loans released from banks.

The central bank should not only pay attention to CPI, but also to the fluctuation of asset prices-particularly housing prices before they drive consumer prices up.

Easy credit will enable real estate developers to get access to low-cost financing and thus help fuel the housing market. In return, the housing market bubble will put lenders in risk and drive up prices of other commodities. As things stand, the main inflation concern that management should focus on is regulating loans for housing.

(This article was first published in Chinese on October 28 and translated by He Shan.)


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