China Should Import Deflation

BEIJING – With China’s inflation – and inflation expectations – rising, how can price stability be maintained without threatening the country’s booming growth? Reconciling growth and fighting inflation is not impossible, but it does require that the government overcome its deep-seated suspicion of opening China’s markets to imports.

The World Bank predicts 3.5% growth for the world economy this year, and most analysts predict that the United States will grow at a similar pace. As a result, external demand for China’s exports will be strong, while the interest-rate differential between China and the world’s advanced economies is resulting in massive capital inflows. Thus, China will continue to accumulate large foreign-exchange reserves this year.

As a result, the Chinese authorities are now deploying a combination of tools to stabilize domestic prices. With the reserve ratio of banks already at 19.5% and unlikely to be raised by a large margin, interest rates will most likely continue to be raised.

Indeed, the benchmark interest rate reached 7.47% in August 2008, after a five-year climb. Given today’s current lending rate of 5.56%, the authorities have a great deal of upside room.