Economy

Rein in inflation and bubbles

By Sun Lijian (China Daily)
Updated: 2011-02-26 07:21

China has to tread carefully with its policies, for its economic development faces internal as well as external challenges

At a recent meeting to discuss this year's Government Work Report and the draft outlines of the 12th Five-Year Plan (2011-2015), the Political Bureau of the Communist Party of China Central Committee once again stressed the need to prevent big fluctuations in the national economy.

A variety of macro-control measures adopted at the beginning of this year reflect the central government's efforts in this direction and its intensified determination to curb inflation and dry out the excess liquidity from China's capital and property markets.

Because of uncertainties in the internal and external economic environments, the government, however, should try to prevent its measures, aimed at curbing inflation and deflating real estate bubbles, from weakening the emerging but still fragile economic vigor.

If the economic vigor is weakened, it will cast a dark shadow over the otherwise remarkable achievements of the government during the past years in rescuing the rocky economy, and increase the cost of any future economic stimulus package.

The eruption of unexpected turbulence in some parts of the world has created uncertainty for China's economic development. If the ongoing political chaos in the Middle East and North Africa intensifies, it will further dampen people's hopes from the global market and increase speculation in oil and other commodities of strategic importance. That, in turn, would create a big problem for the world economy, which is still in nascent recovery.

Rising oil prices, together with the dilemma many countries already face - whether or not to raise interest rates to remove excess liquidity and other side effects of their economic stimulus packages - could possibly result in reversal of their policies and cause greater uncertainties for their future economic development.

Some developed countries, led by the United States, have achieved a better-than-expected economic upturn. If their economic recovery has a solid basis, their next step possibly would be to take measures to curb the side effects brought about by economic overheating. As a move in that direction, the US Federal Reserve and the European Union's Central Bank are likely to accelerate increasing their interest rates.

China's possible failure to respond timely to such moves will disrupt its efforts to curb the speculative flow of international capital into the country and hurt its macroeconomic regulations in the earlier stage. The problems that were exposed in China's economy after the global financial crisis struck, such as the widening fiscal deficits, uneven trade balance and the huge pressure to raise its exchange rate, will possibly increase. That, together with its comparatively weak capability to promote international coordination to cope with similar global issues, could evoke overreaction from the domestic and overseas markets.

Besides, the resurfacing of the sovereign debt crisis in Europe, lowered credit ratings on state bonds of Japan, the US, Britain and some other developed countries, and China-US trade frictions, will also pose a major challenge to China's economy.

The country should not underestimate the importance of internal uncertainties to its economic development. The low per capita income and huge income gap between the rich and the poor have squeezed China's space to endure the rise in inflation, caused by either imported factors or oversupply of its own currency and the lack of effective control over excess liquidity. A monetary policy alone cannot effectively rein in current inflation.

China is under tremendous pressure to restructure its economy, too, a move that is particularly crucial for boosting the country's economic vigor. Like many other countries, the government-dominated economic development model has regained ground in China after the global financial crisis struck. In such a situation, the vulnerability of the government-dominated policy market will be exposed by intensified macroeconomic regulations, for they will undercut the possibility of sustainable development of the national economy. Plus, the recent labor shortage and wage rises in some regions, if not handled properly, are likely to hurt domestic enterprises' ongoing struggle for economic restructuring.

In the face of such internal and external uncertainties, China should try to treat inflation and bubbles with scientific perspective, because any miscalculation or reckless action can have the opposite effect.

To this end, the country should embrace a scientific macroeconomic regulatory method on the basis of proper exchange rate and interest rate policies, and expedite the establishment of its monetary system with the aim of minimizing the negative effects of possible financial bubbles on commodity prices.

The government should take more measures to increase capital input into human resources and set up a proper incentive mechanism to promote the country's industrial structural upgrade. A better performance of the real economy will help reduce inflationary pressure created by the flow of excess liquidity into the financial sector.

At the same time, the government should strengthen policy coordination among different decision-making departments and publicize the research results of academic institutions on China's economic development. That will help people to know exactly what the national economic prospects are.

The author is deputy dean of the School of Economics at Fudan University.