Most of the developed and developing nations of the world are striving hard to maintain the growth rate of their economy and control the rate of inflation. For the purpose of attainment of sustainable economic growth which is coupled with an overall price stability, all the countries have emphasized upon controlling various macroeconomic factors that contribute towards inflation in their fiscal policies. It is often suggested that mild degree of inflation is beneficial for economic growth as it encourages people to consume more without affecting their savings (Dwivedi and Dwivedi, 2005). But over the past few decades China has experienced unprecedented economic growth along with this economic growth the inflation has also seen a gradual growth (Zhu, 2012). Despite of all the efforts from several frontiers no one has been able to bring inflation under control. This article presents an overview of the trend of inflation in the Chinese economy over past few years and also the causes that are responsible for the increase in inflation rates. At the end, the article will present several recommendations based on the discussions which can be employed and have been employed by others. These recommendations shall help in controlling the inflation in one of the fastest growing economies of the world.
An overview of the Chinese economy
When the economy of the World was crumbling under the burden of global depression triggered by the sub-prime crisis and fall of Lehman Brothers; the Chinese economy was on a steady growth path. This growth was due to the fiscal stimulus provided by the government. This fiscal stimulus resulted in increased spending by the Chinese population in the domestic market (The Economist, 2011). The high growth rate of the Chinese economy led everyone to believe that this growth will continue forever, but the increasing inflation rate seems to move it closer to the phase where this bubble of growth will burst. The inflation has not only affected the price of food items alone but it has also affected the prices of various non food items as well. The policy makers struggled hard to bring the inflation rate under control and to a certain extent they had succeeded. The inflation rate in China was reported to be at 1.4 % which was at the lowest in the year (tradingeconomics.com, 2014). The image below shows the inflationary trends in the Chinese economy between 2001 and 2013:
Causes of the rising inflation in China
The government in China opted for expansionary monetary policies, this coupled with increasing wage rate resulted in increased inflation over a period of time (Liu, 2014). The inflation that was caused in the Chinese economy was primarily cost pushed inflation which was caused by the rising cost of production. And in this case the cost of production was rising owing to increase in wages (Zhiyong, 2008). Demands for higher wages were an outcome of the demographic shift that the country experienced (Banister,1992; (China’s Inflation and Labour Shortage Problem and Hugh, 2008)
The one child policy which was implemented by the Chinese government in the year 1979 resulted in decreased number of young population. The median age subsequently increased to over 35 years in 2011 (Statista, 2014). And as the working population grew older they started seeking higher wages. As the population growth rate of the young generation continues to decrease, the supply of workforce will also go down and demand will increase, leading to increased prices (China’s Inflation and Labour Shortage Problem and Hugh, 2008).
Government policies have also contributed towards the increase in inflation. In the 12th five year plans the government has asked the business organizations to increase the labor wages by 13 percent every year so as to curb any type of inequality and poverty.
Another temporary reason for this inflation is the rising food prices. The supply of food products went down due to poor weather conditions and lack of proper distribution channel (Telegraph.co.uk, 2012).
Also, the value of Chinese currency Yuan has gone down and amount of money leading to huge inflow of money hence it is a classic case of “too many Yuan chasing too few goods and services” (Pettis, 2008) further increasing their prices.
Impact of inflation on China
There are several classes of people whose income remains fixed despite of rising prices. They are pensioners or those who are dependent on social security benefits for their survival. In such case of increasing inflation they are the worst hit. The effective rate of income of the general will be reduced as they will be spending more than what they will be earning. This will lead to less investments hence negatively affecting employment rates and increasing the chances of wage disputes. This shall reduce the productivity of the nation and which will adversely show its impact on The Foreign trade and exchange rate. The products that are being produced in China will become comparatively dearer than the products that are being produced in other countries.
Experiencing high rates of inflation, China’s domestic products will be less competitive internationally (Dwivedi and Dwivedi, 2005). 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.
Controlling the rate of inflation
Though certain degree of inflation is inevitable for sustaining the growth of the economy but it is very important to keep the menace under control (Zhang, 1994). Despite best efforts of the government, they have so far failed in controlling it. One way can be to provide subsidies to the business organizations so as to bring down overall cost of production leading to lower prices of the goods and services. Otherwise the government can also opt for appreciation of currency. This way the business organizations will be able to procure raw materials at lower prices and bring down the cost of production. The appreciation can be brought in by using foreign exchange reserves for the purchase of Chinese currency leading to increase in its demand and subsequent appreciation. Even though these methods can help in curbing inflation but these methods cannot be opted as long term measures. The Government will have to improve the monetary and fiscal policies with a long term perspective for controlling the menace of inflation in the long term.
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