IA: Inflation

This commentary will explore the inflation and its causes in China, as well as evaluating it in terms of pros and cons. This article on inflation from BBC News on May 11, 2011 states that China’s inflation has slightly cooled due to the government’s efforts to ease inflation. This inflation that has been a concern for China comes about from the surge in economic growth, where the GDP and the living state of people increase, and the rise in prices.

Inflation is when the general prices of goods and services increase within an economy. There are essentially two types of inflation – demand pull inflation and cost push inflation. In theory, when the aggregate demand, the total demand for a good or service in a given time period, increases, and when the aggregate supply, the total amount of goods and services that an industry can produce at a given time period, decreases, there is inflation within the economy.

Figure 1 shows a cost-push inflation, where the aggregate supply decreases. Because this AS curve shifted to the left, the real GDP has decreased from Y1 to Y2, but the price levels have increased from P1 to P2. As the article explains that “rising food, fuel, and housing prices” has been problematic, this shows that there has been a cost push inflation.

Another type of inflation is the demand-pull inflation shown in Figure 2. As you can see, the aggregate demand increases. This causes inflation as well because both the real GDP and the price levels increase from Y1 to Y2 and from P1 to P2. In China, there has been an economic growth, and we can assume that this has resulted in an increase in demand.

To decrease inflation, there can be two things that can be done. Fiscal policy, which is the use of government expenditure and taxation to manage the economy, and monetary policy, which is the use of interest rates and money supply changes to manage the overall level of demand in the economy. The use of both policies will in theory help reduce inflation.

In China, only the monetary policy is used to reduce inflation. In the article, it explains how “the government’s previously loose monetary policy was the fundamental driver behind price rises”. As shown in Figure 3, the AD curve has shifted to the left, as monetary policies usually deals with the demand side, which results in a fall in inflation. This can be seen as food, fuel and housing prices have remained high; however, it has fallen 0.5% from 11.7% last month to 11.2%, and in addition China’s central bank “raised the cost of borrowing four times since October, and asked banks to hold more money instead of lending it out”. Such policies led to a fall in the annual inflation rate to 5.3%.

To evaluate China’s actions in attempting to reduce inflation, pros and cons are an aspect to look at. The government of China’s attempts to decrease inflation with monetary policies has helped the demand side to fall which is a good thing; however, it does not really describe actions that would deal with the supply side. Inflation does not only deal with the demand side, and so there is a necessity to also deal with the supply side. To do so, they will need to deal with fiscal policy. Although it explains in the article that “investment in fixed assets such as roads, buildings and factories also climbed”, that is not enough to help the supply-side. However, assuming that China does not want to deal with the supply-side as much because they do not want to provoke any more unemployment, their actions in reducing inflation is successful.

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One Response to IA: Inflation

  1. Pingback: Portfolio Semester 2 | Kanako's Blog

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