Chinas Inflation and related factors - Essay Example

? China’s Inflation and related factors China’s Inflation and related factors Thesis: select a newspaper/magazine/web article for economic analysis. Outline: 1. Introduction 2. Points Highlighted from the Newspaper Article 3. What is Inflation and Why Inflation increased in China? 4. Why tightening Policies would help? 5. What is price stability and why it’s necessary to maintain it? 6. Why increase in CPI causes concern for China? 7. Conclusion 8. Work Cited Introduction This excerpt is from Dow Jones Newswires magazine. It considers the rise in inflation in China with connections to variations in GDP rate. The article even highlights the factors that are attributed to such rising inflation and GDP. Moreover, it focuses on the measures utilized by the Federal Reserve to tackle inflation. Additionally, it emphasizes the importance of price stability within the Chinese economy with specific concern to the fluctuating CPI (Consumer price index). The article talks about persistent inflation in China. The models and theories used in this article are: 1. Demand-Pull Inflation 2. Price Level connection with Real GDP 3. Business Cycle 4. Monetary Policy 5. Price stability 6. Consumer Price Index Points Highlighted from the Newspaper Article but inflation accelerated to a nearly three-year high in March, (GDP figure is better than expected) GDP figure is better than expected tightening monetary policy, consumer price index rose 5.4 per cent from a year China's producer price index, CPI fell 0.2 per cent China's anti-inflation policies were effective. necessary to maintain price stability inflation almost always falls in the month after the Lunar What is Inflation and Why Inflation increased in China? What Does Inflation Mean? The rate at general level of prices of items and services rises. The subsequent fall in purchasing power is also result in inflation. Central banks try to stop the severe inflation, along with the severe deflation, in order to keep the excessive raising of prices to minimum. Economists distinguish between the two types of inflation: Demand-Pull Inflation and Cost-Push Inflation. (Defining Inflation )Both types of inflation may cause an increase in the economical price level within the economy. Demand-pull inflation may result when aggregate demand for goods and services in the economy rise at a rapid space than an economy's productive capacity. This is shown in the figure below The excess demand is the reason for consistent inflation in the economy. Moreover, experts also attribute China inescapable inflationary spiral to US dollar pegging as long as China Yuan keeps pegged to the U.S. dollar, it will rise. This is because the American economy is weakening where as the China economy is strengthening (What is the real reason behind Chinese inflation, 2011) China therefore needs to control Yuan appreciation (China Inflation cause concern in Business News , 2011) During the peak periods of business cycle when China’s economy is experiencing growth in real GDP, employment will naturally increase, and unemployment decrease would decrease, this is because the businesses would seek workers to produce a higher output to fulfill demand needs. If the real GDP grows better this can cause price inflation as firms would be forced to fight against one another for generally increasing scarce workers. This is in contrast during the trough periods of the business cycle where the economy is experiencing declines in the real GDP, and unemployment rates becomes high. GDP = (Total dollar value of goods and services that are changing hands) MINUS (Inflation) GDP can grow, even when there is inflation GDP is: Yes, GDP (Gross Domestic Product) can even grow, when there is inflation. But for such to happen (theoretically) more goods and services would actually need to be exchanged, rather than having the same prices for the same amount of goods and services. One of the reasons that the China’s Economy is able to claim that GDP ( Gross Domestic Product) is growing is that the Fed and the China Government are "fudging" the influence on inflation statistics through the use methodologies. Tightening Policies Why tightening Policy would help? The China essentially has two of these weapons in its arsenal to help guide economy toward path of stable growth that is without excessive inflation; either monetary policy or fiscal policy. Fiscal policy comes with the government in the form of the taxation and the federal budgeting policies. While the fiscal policy can be very effective in several specific cases to spur the growth in the economy, most market watchers would look to the monetary policy to do most of heavy lifting in keeping economy in stable growth pattern. In the China, the Federal Reserve Board is charged with implementing the monetary policy, which can be defined as any action taken to limit or increase amount of money which is circulating in the any economy. China can use monetary policy to impose controls with the help of Federal Reserve (the Fed) can make money either easier or harder to come by, therefore encouraging the spending to spur the economy or constricting access to the capital when its growth rates are reaching at what are deemed to be unsustainable levels. (Macroeconomics: Theory and Policy) What is price stability and why it’s necessary to maintain it? Price Stability Price stability is the condition in which average price level in any economy does not change or it either changes very slowly. This is essential for macroeconomic goal of stability. Price stability is usually indicated by the inflation rate, calculated usually as the percentage changes in either the Consumer Price Index (CPI) using the GDP price deflator. However, if seen more generally the price stability is the ABSENCE of large or the rapid increases or decreases in the price level. (Price Stability in Glossary 2011) Importance of price stability for China The objective of the price stability refers to general level of prices in the economy would naturally imply avoiding both of the prolonged inflation and deflation. Price stability contributes in achieving high levels of the economic activity and employment by improving the principle of transparency in price mechanism. Under the price stability people can recognize changes in relative prices (i.e. prices between different goods), without being totally confused by changes in such overall price level. This would allow Chinese government to make well informed consumption and investment decisions along with allocating resources more efficiently; It would also help in reducing the inflation risk premia in the interest rates (i.e. compensation to creditors ask for the risks associated with any holding nominal assets). This would reduce the real interest rates and increase the incentives to invest. Moreover, avoidance of unproductive activities would also hedge against the negative impacts of inflation or deflation. The important impact of price stability is reduction of distortions of inflation or deflation that could have exacerbated the distortion impact over Chinese economic behavior of tax and social security systems. Last but the least price stability would prevent any arbitrary redistribution of wealth along with income as a result of any unexpected inflation or deflation. Price stability should always remain the main target of China’s monetary policy, as the central bank official said.(cn businessnews) Consumer Price Index CPI is an indicator that is used for measuring the inflation. It considers what people are spending on staple goods and services. It is calculated generally by taking the average of the changes in price to basket of goods and services compiled. The goods and services that were in the basket are then weighted accordingly with their perceived importance. CPI is a considered primary tool in determining how the people or economy is experiencing inflation. (financial dictionary) In China some of the things that it tracks generally are housing, food, transportation, medical care, clothing, and education. The CPI can be used thereby as a benchmark for making adjustments in the social security wages, pensions payments, , and tax brackets to keep them all in tune with buying power of the Yuan. CPI can be measured using CPI Indicator Why increase in CPI causes concern for China? Increases in the CPI level would serve as a measure of the economy’s consumer inflation rate. The rate of inflation that is occurring over a period of time would simply be the percentage increase in CPI over the period, often reported as on an annualized basis. If the CPI index number rises excessively, that would means the cost of living is raising and therefore the inflation, which in turn would cause the Federal Reserve to take certain appropriate measures to contain it. It is important to not to get too much concerned about monthly changes in the CPI. Rather one must look at things as a whole it is important to look at the changes happening over a longer period such as over and above few months or a year. This is important as seasonal price changes would generally cause temporary fluctuation in price of goods without un necessarily creating inflation! In the Lunar days as the demands for the products and services fluctuates therefore changes in inflation rates are expected therefore inflation in lunar days should not be considered as an appropriate judging factor. Conclusion It is important for Chinese Economy to understand the factors that are causing increases in price levels. With it touching the list of super powers any inflationary affect would affect the world economy. It is important that measures such as the tightening policies (both fiscal and monetary policies) are used as tactics to contain the ever rising inflation. The Fed Reserve must watch the credit supply to influence the money in and out flow in the economy. Furthermore, it should be realized that price stability is of peak importance and therefore should be kept. Indicators such as CPI and GDP factor could help judge the economy state better. Once the economy is judged better it could be run better. Work Cited 1. China Inflation causes concern in Business News (2011) http://www.upi.com/Business_News/2011/01/11/China-inflation-causes-concern/UPI-70911294802163/ 2. China Inflaiton Yuan peg dollar in ibtimes (2011) 3. Consumer Price Index in Financial Dictionary (2011) http://financial-dictionary.thefreedictionary.com/consumer+price+index 4. http://www.ibtimes.com/articles/109256/20110206/china-inflation-yuan-peg-dollar-us-fed-interest-rate.htm 5. Price stability main target of monetary policy in CN Business News (2011) http://cnbusinessnews.com/price-stability-main-target-of-monetary-policy/ 6. Price Stability in Glossary (2011) http://glossary.econguru.com/economic-term/price+stability 7. Inflation in Investopedia (2011) http://www.investopedia.com/terms/i/inflation.asp 8. Robert J. Gordon (1988), Macroeconomics: Theory and Policy, 2nd ed., 9. Shostak, Ph. D, Frank (2002-03-02). "Defining Inflation". Mises Institute. http://mises.org/story/908. Retrieved 2008-09-20. Read More