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.

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

    FMF Policy Bulletin/ 10 May 2011

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