Why China’s Leaders Fear Inflation
Image Credit: Richard Fisher

Why China’s Leaders Fear Inflation


Inflation is universally viewed as a scourge. But it appears to be seen as a worse scourge in China than in other countries.  At the moment, Beijing is obsessed with keeping the annual inflation rate below 4 percent, its declared target. Yet based on the latest figures, the government is losing the inflation fight.

First, some data and a little background.  To be sure, rising inflation isn’t a recent economic challenge for China—prices were spiking as early as last autumn.  What makes China’s recent round of inflation fighting interesting is the apparent ineffectiveness of the measures adopted by the government, including raising interest rates, hiking the bank reserve ratio (so that less money is lent out), and imposing price controls on some goods. According to official data, China’s consumer price index (CPI) rose 5.3 percent in April, following a slightly higher increase of 5.4 percent in March.  The inflation numbers for the last six months kept hovering around 5 percent per annum, considered high by China’s historical standards (the average inflation rate per year was 4.3 percent from 1994 to 2010).

For a rapidly growing economy such as China’s, some inflation is inevitable. But in the Chinese case, there are additional causes fuelling price increases. The massive credit boom unleashed by the Chinese government to revive growth in 2009 obviously succeeded—perhaps too well.  Tighter labour supply, due to changing demographics, has pressured wages upwards.  Global food price hikes have also hit China—food price inflation for April was 11 percent, which was double the CPI. 

The problem could be being compounded by Beijing’s policies. For a start, interest rates are too low.  Despite recent increases, the one-year lending rate today is 6.31 percent a year, barely one percentage point above the inflation rate.  The deposit rate, at 3 percent a year, remains negative, making putting money in Chinese banks a losing bet. Quantitative tightening through raising the bank reserve ratio, meanwhile, has been ineffective—since last October, Beijing has increased the bank reserve ratio eight times, to a record of 21 percent (meaning that one-fifth of bank deposits can’t be loaned out).  However, China’s shadow banking system, consisting of various non-bank finance companies and clever regulation-evading schemes, is hard to subdue.

So it appears that rising inflation will be with China for quite some time, raising an interesting political issue: will rising inflation create social instability in China, and if so, how?

Chinese leaders have good reason to fear rising inflation.  The Kuomintang government lost the Chinese civil war to the Communists in the late 1940s, as the legend goes, mainly because it allowed hyperinflation to destroy the wealth of the urban middle class. Another anecdote frequently cited by observers of China was the Tiananmen pro-democracy movement in 1989.  In 1988, China’s failed price reform led to price spirals and panic buying in cities. So some observers attributed the massive nationwide protest that occurred in the spring of 1989 to high inflation at that time.

July 17, 2011 at 07:02

Germany also had hyper nationalism due to the re-partitions for WW1.
This put the German economy in heavy debt, the govt. decided to print money in order to keep the engine running, this caused inflation. Now you need a damn wheelbarrow full of money to buy a loaf of bread. Hitler was seen as good soldier for being in WW1, and a political activist for his writings.
When the elections came, he promised to fix the economy.
When he did he had uni-lateral control.

Leonard R.
May 28, 2011 at 11:01

I think inflation in China is higher than official numbers show. And it includes food inflation. I have not priced rice. But I had noticed restaurants seemed more stingy with it. Shame on them. They raise prices & cut back on the rice portions.

It’s interesting how much scrutiny is given to RMB bills by shop clerks too. I suspect there are a lot of counterfeit RMB notes floating around in the PRC. I don’t know how much that adds to inflation.

The author wrote:

“The critical political function performed by inflation is coordination…”

That’s an interesting way to look at it, a little paranoid perhaps. But it’s interesting. And who can disagree? It is much easier for governments to remain in power if inflation is manageable. Inflation provides a common grievance against the government.

In China, there seems to be a thin line between normal life & all-out panic. It’s a character trait that cannot be blamed on the CCP. It’s been that way for thousands of years.

May 24, 2011 at 08:27

You have finally written an article I agree with. Though I might add that there is one other major economy who shares Beijing’s inflation-phobia: Germany.
The last time they let inflation run wild, they ended up with Hitler.

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