Readers Question: How about the case of cost push inflation like that of China? there’s high inflation and yet the economy is not operating at its full level of employment and due to the fact that its exchange rate is fixed, monetary policies would not be effective but fiscal policies would further increase unemployment. What policies can be implemented to reduce this cost push inflation in a fixed exchange rate system?
Comment on post: Economic Policies to reduce inflation
It’s a good question. Inflation in China has recently reached an 11 year high of 7.1% (inflation China)
The Chinese blame rising food prices and rising oil prices. However, I would also blame the Chinese government for allowing demand to rise too quickly.
Loose Monetary Policy. The benchmark interest rate in China is currently 7.4%. Although it has been increased several times in the past 12 months, it still represents a very low real interest rate 0.3% (7.4-7.1%) Compare that to the UK, where real interest rates are closer to 3.0%. The low cost of borrowing is encouraging a boom in borrowing, but often the borrowing is badly directed and it could contribute towards a boom and bust in the Chinese property markets.
Undervalued Exchange Rate. Although the Yuan has appreciated in the past couple of years (although the exchange rate is supposed to be fixed it has been allowed to be gradually revalued) However, it is arguably still undervalued. The Chinese government is keen to keep it artificially low to stimulat export led growth. The weakness of the Yuan is indicated by the size of the Chinese Current account surplus.