Inflation rate in China reaches tipping point

Despite efforts to rein it in, China's inflation rate has reached a point where it is sparking social unrest. Chinese premier Wen Jiabao's recent comment that inflation is a tiger that "once set free is very difficult to put back in its cage" aptly characterises the current inflation in his country. The world's second-largest economy faces some fundamental choices if it is to restore stability, says John H. Makin, a resident scholar at the American Enterprise Institute.

In a new study, Makin makes these key points:

China is facing destabilising inflation; capital has flowed into China much faster than it has flowed out, in part because Chinese residents are prohibited from investing abroad.

China's reported inflation rate on consumer goods rose to 5.4 per cent in March, but its implied inflation rate is 8.4 per cent – a large discrepancy suggesting that China is underreporting its inflation rate.

Chinese authorities have taken some steps to lower inflation, but they may be delaying more drastic measures to avoid instability before the 2012 transfer of leadership.

China has the second-largest economy in the world – accounting for one-third of global growth in 2010 – so a Chinese hard landing would be very damaging to the global economy.

Source: John H. Makin, Why China Overheats, American Enterprise Institute, May 2011.

For text: http://www.aei.org/outlook/101048

For more on Economic Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=17

First published by the National Center for Policy Analysis, United States

FMF Policy Bulletin/ 10 May 2011