Caixin
Sep 04, 2018 01:35 PM
OPINION

Editorial: China Must Actively Manage Inflation Expectations

The prices of many goods have risen recently, causing the public to worry about inflation. Inflation is related to the national economy and the people’s livelihoods, so the government has a duty to guide and manage expectations while preventing inflation from escalating. The government should effectively control the currency supply, maintain stable economic development, and change its one-sided approach to the consumer price index (CPI) to make relevant information more openly available in order to maintain and boost the confidence of consumers and investors.

Due to a combination of international and domestic factors, the price of vegetables, eggs, pork and other food products, as well as rents in some areas, have skyrocketed recently. This — combined with the impact of rising global oil prices and the depreciation of the yuan — has created a certain level of inflation pressure in the domestic market. But many analysts believe that there is little reason to expect a long-term widespread increase in prices.

China’s current economic situation is complicated, and some factors encourage inflation, while others suppress it. The future will be determined by which side gains the upper hand. On one hand, growth is increasingly slowing down, and total social demand is falling. On the other hand, the Chinese government is now applying fiscal policy more actively while marginally relaxing monetary policy, and some energy and raw material prices have recovered after nearly three years of supply-side, capacity-cutting reforms. These factors may drive up prices throughout entire industrial chains. At the same time, there are some random, seasonal and temporary factors. In the context of increasing internal and external uncertainties, the risk of inflation cannot be taken lightly.

Inflation can be understood on three levels. One is asset inflation, which includes home and stock prices. The second is target inflation, which involves foodstuffs and energy prices. The third is core inflation, which refers to the inflation rate calculated after foodstuffs and energy are excluded. Inflation usually starts as a more general trend before manifesting in spikes of specific goods’ prices. Focusing on the core inflation rate or CPI alone will cause one to misjudge the situation, resulting in serious consequences. This is the profound lesson governments across the world learned after the global financial crisis 10 years ago. China’s CPI has not been hit by a major spike in recent years, making it easier for people to become numb to inflation.

Take the case of soaring rents in Beijing, which have caused widespread concern recently. Some analysts have said that the current round of rent hikes cannot be sustained, and is only a response to the fierce increase in home prices Chinese cities have experienced in the past three years. This view is not baseless, but the problem is the assumption that soaring rents are acceptable simply because they can be explained by pointing to rising home prices. After all, rising rents will translate into increased costs for sellers of other commodities, which in turn will push up commodity prices. Asset price inflation should be viewed as a manifestation of inflation. But regrettably, the Chinese government at various levels has for a long time failed to address this problem. Regardless of any academic basis for doing so, the facts show that ignoring asset price inflation while judging the overall inflation system is a harmful practice, and can be considered a “lazy” approach to governance.

Ultimately, inflation is a monetary phenomenon. No matter what factors are causing domestic prices to rise, if liquidity is not greater than the actual demand for money, inflation will not occur. Since the start of this year, faced with downward pressure on the economy and the task of deleveraging, the central government, learning from past experiences, has focused on marginally relaxing monetary policy without engaging in “massive stimulus.” It has also striven to control the level of new local government debt. The recently convened Politburo meeting called for continued implementation of active fiscal policy and stable monetary policy, saying that “fiscal policy should play a greater role in expanding domestic demand and structural adjustment,” while China should “have a good grasp of the monetary floodgates and maintain a sufficient and reasonable level of liquidity.” The recent appreciation of the U.S. dollar and the escalation of U.S.-China trade friction has put pressure on the yuan to depreciate. This, combined with high international crude oil prices, is likely to result in imported inflation. Despite this, the central bank has maintained its resolve, which is commendable.

It’s worth noting that expectations of inflation tend to be self-fulfilling prophesies. A worsening in the economic situation could create a vicious circle, resulting in financial and fiscal risks. Therefore, it is extremely important to appropriately guide expectations, especially while inflation is still in the early stages of building momentum.

In order to manage expectations, China should first create an accurate, objective, and credible measure of inflation. The CPI, which is the most closely watched indicator, has long been the subject of doubts over its accuracy because it is often far removed from the public’s perception of prices. Unfortunately, the main reason for this is that the CPI’s composition and the weight given to each product is neither reasonable nor transparent. A typical example of this disconnect is how the rise in rents and changes in the cost of living have not been reflected in the CPI. This not only causes the index to lose market credibility, it can also easily lead to misguided policies.

In order to manage inflation expectations and maintain market order, government regulatory policies should be more precise. At the same time, the government must build a public platform for sharing information on supply and demand, to supplement transaction information available to the market. Timely warnings should be given for price fluctuations, and policies should be pre-adjusted in order to guide and stabilize expectations. Of course, the most basic measure should be to improve China’s economic fundamentals. At the moment, small and midsize enterprises are struggling. It should offer support in difficult times, instead of adding more obstacles for small and midsize businesses.

It is disturbing that, while domestic inflation has not fully appeared, there is already discussion of “stagflation.” The combination of economic stagnation and inflation is undoubtedly one of the worst combinations for any economy. It is impossible to say for sure if China will experience stagflation in the future. Nevertheless, it is definitely a situation the government should avoid. Stagflation is essentially the long-term failure of monetary policy to stimulate aggregate demand. As the several rounds of steady growth experienced by China since the global financial crisis show, monetary stimulus clearly does more harm than good. In order to avoid the trap of stagflation, the fundamental policies should still be institutional reform and structural adjustment. The most urgent tasks for China are to further promote supply-side structural reforms, and achieve economic restructuring and upgrading.

It has been hard for the monetary authorities around the world to resist printing excessive amounts of money ever since credit currency gained widespread use. Inflation and employment are two major economic issues affecting people’s livelihoods and social stability. History has taught China and other countries painful lessons about the dangers of inflation. China’s economic fundamentals are still good in the context of the global situation. The government has the capacity to guide and properly manage inflation expectations, and also has a rare time window to prevent inflation from escalating.

Translated by Teng Jing Xuan (jingxuanteng@caixin.com)

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