Impact of Inflation on China's Economy

Chinese inflation is rising too fast

But it’s had another major side effect. The Chinese economy is fast overheating. All that extra liquidity is driving up prices and wages, while property values have soared. In October, the official figures showed China’s cost of living climbing by 4.4% year-on-year. That was the fastest increase in more than two years.

And the situation may be rather worse than this. Two weeks ago a pundit at the Chinese Academy of Social Sciences, one of the government’s top think tanks, said that by its own calculations the country’s consumer price index had been understated by more than 7% over the past five years. And last week the original ‘Dr Doom’, Marc Faber, said he reckons the ‘real’ Chinese inflation rate is nearer 10% a year.

Whatever the exact figures, there’s no doubt inflation is rising far too fast for comfort for the authorities. The Chinese central bank has been trying to cool things down gently.

Five times this year it’s raised bank reserve requirements, which reduces the amount that lenders can lend. Yet “the credit brakes are being tapped, not slammed”, says the FT. “The government could be more aggressive.” In other words, so far the tightening hasn’t had much of an impact.

The workforce is getting far stroppier than it once was. Between 2007 and 2008 – the latest available data – labour disputes more than doubled. Food prices are already rising at 10% year-on-year. The Xinhua news agency reported last week that a basket of 18 staple vegetables cost 62% more during the first ten days of November than in the same period last year.

So higher wage demands are likely to become more frequent “as most of the population lives close to the edge”, says the FT. In fact, it’s starting to look like China’s inflation problem has now got rather out of hand.

This article is talking about the inflation occurring in China and the costs that it has brought to China. This inflation has caused severe consequences to China and we will be discussing the possible solutions

inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time.

Costs of inflation in China:

When inflation rates are high, groups such as pensioners, households, dependent on social security benefits, stand lose to a great deal since they are often on fixed incomes. These Chinese will now be able to purchase less than before (less purchasing power), and will start to demand for higher wages. Only those with strong bargaining positions will be able to bid up for higher wages. In addition, people will be able to buy less food items than before which is a major issue because food is one of the basic necessities in human life, as in the article it has shown the the prices of food increase 10% year-to-year.

Inflation causes an increase in interest rates and will therefore have a negative effect on investment and output, both of which will adversely affect employment, as in the article we can see that labour disputes have been doubled

Higher inflation means that the businesses in China will have to change their prices to keep up to date on the price level.

Inflation affects the foreign trade and the exchange rate. Experiencing high rates of inflation, China’s domestic products will be less competitive internationally. As the domestic products’ prices increase the demand for these products will fall and therefore the demand for China’s currency will also fall, thus affecting the exchange rate.

The cause of inflation in China:

The cause of inflation in China’s economy was expansionary monetary policies and rising wages. The inflation in China was caused by “cost-push inflation. It means that the cost of firms increase, in this case it is higher wages, and the firms are forced to raise prices inorder to cover the costs.

Cost-push inflation

If the economy demands higher wages, the higher costs of labour will shift the SRAS curve to the left from SRAS1 to SRAS2. The price level rises from P1 to P2. Higher wages increase consumption and therefore increases aggregate demand from AD0 to AD1. The increased spending (and possible expansionary policies) move the economy towards equilibrium at Yfe but at a higher price level. We have now a round of cost-push inflation.

Solution:

In the article, it has shown that China’s government is trying its best to avoid this issue but it has been said that it hasn’t had much of an impact.

One of the possible ways of reducing inflation is by subsidizing businesses. The government can give out subsidies to business so that the businesses can reduce their costs of production. This will then encourage the businesses to lower their prices and thus avoiding inflation. The problem here is that the government will suffer a huge loss if there are many businesses to subsidize.

Another possible solution is by appreciating its currency. This is because if it appreciates its currency then firms will be able to buy cheaper raw materials and therefore will have lower costs of production. Thus reducing prices of goods. It can appreciate its currency by using its foreign currency reserves to buy its own currency and this will increase the demand for its currency. Even though this method will help businesses to reduce their prices, there are also negative consequences.