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Can China Beat Deflation?

After 39 consecutive months of declining producer prices, deflation is becoming a serious concern among Chinese economists and policymakers. Given slowing economic growth and massive corporate debts, China’s authorities should learn from the recent past to avoid a deflationary spiral.

BEIJING – At a time of slowing economic growth and massive corporate debts, a deflationary spiral would be China’s worst nightmare. And the risk is mounting. The producer price index (PPI) has been in negative territory for 39 consecutive months, since February 2012. The growth of China’s consumer price index (CPI), though still positive, has also been falling steadily, from 6.5% in July 2011 to 1.2% in May. If past experience is any indication, China’s CPI will turn negative very soon.

In China’s last protracted bout of deflation, from 1998 to 2002, persistent declines in prices were the result of monetary and fiscal tightening that began in 1993, compounded by the lack of exit mechanisms for failed enterprises. After peaking at 24% in 1994, inflation began to decline in 1995. But GDP growth soon began deteriorating rapidly. In an effort to revive growth in a difficult global environment and buffer exports against the impact of the Asian financial crisis, the Chinese government loosened monetary and fiscal policy beginning in November 1997.

But it was too little too late. By 1998, when CPI inflation began to fall, producer prices had already been declining for eight months, and remained negative for a total of 51 months, with CPI growth beginning to recover after 39 months.

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