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China needs to adjust its monetary policy now

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1 China needs to adjust its monetary policy now on Sun Apr 18, 2010 8:30 am


China needs to adjust its monetary policy now
April 18th, 2010

Author: Yiping Huang, Peking University and ANU

Policymakers have been contemplating the options for exiting from expansionary monetary policy since late 2009. It now looks that time is ripe for the People’s Bank of China (PBOC) to tighten monetary policy. Ideally, adjustments to both interest and exchange rates should take place simultaneously.

Economic data for the third quarter and March released by China’s National Bureau of Statistics (NBS) last week was largely in line with market expectations. Despite the ongoing debate among economists about overheating, current trends of accelerating growth and price increases are clear. Real GDP growth was 11.9 per cent during the first quarter, more than 1 percentage point higher than the growth rate in the fourth quarter of last year and nearly double the 6.1 per cent growth during the first quarter last year.

It is a matter of judgment as to whether the economy is overheating. Some economists suggest that the first quarter’s growth rate may be overstated since the base was low during the same period last year. However, most economists probably share similar views on two issues. First, the rapid acceleration of growth since 2009 points to high risks from overheating. And, second, 12 per cent is probably well above China’s growth potential. Past experience confirms that whenever GDP growth exceeds 12 per cent, inflationary pressure escalates rapidly.

Currently, the inflation rate does not look particularly high. In March, the CPI rose by 2.4 per cent, even lower than February’s 2.7 per cent. However, the real inflation picture may not be as mild as it appears. This year’s Chinese New Year’s holiday fell in February, during which inflation was understandably higher. More importantly, China suffered from deflation during the first ten months of 2009. The CPI barely turned positive from November, but is now already approaching 3 per cent.

Inflationary pressure this year could actually be quite high. According to a recent study by myself and two collaborators, Wang Xun and Hua Xiuping, China’s inflation has a stable co-integration relationship with both excess liquidity and excess capacity in the long run. In 2009, massive liquidity exerted upward pressure on inflation, offset by effects of overcapacity in the opposite direction. Since the beginning of this year, the overcapacity problem has diminished. The relations discovered in our recent study suggest that the CPI could soon reach 7.5 per cent if PBOC does not adjust its monetary policy.

More importantly, inflationary pressures from early last year are showing themselves more in terms of rising asset prices, particularly housing prices, instead of growing CPI. The subprime crisis already demonstrated the potentially devastating consequences of asset bubbles. Does China have a serious housing bubble? Economists remain divided on this issue. Indicators like the rental-price ratio, the income-price ratio and the vacancy ratio all indicate that the housing bubbles in China’s major cities such as Beijing and Shanghai are among the most serious in the world. If that is true, then we should also be prepared to accept serious consequences later on. Perhaps this was why Premier Wen Jiabao and the State Council have become more decisive about reining in housing bubbles.

Is it time for a retreat from expansionary monetary policy? Many central banks elsewhere in the world still have reasons to be cautious about exit. But the answer for the PBOC should be clear. With growth acceleration, the shortage of migrant workers, rising inflation and a ballooning asset bubble, the PBOC really has no excuse for delaying the policy adjustment.

Additionally, it is probably best for the PBOC to adjust the interest rate and exchange rate simultaneously. In effect, pressures on exchange rate policy are even greater, taking into account both domestic and external economic forces. US Secretary Geithner’s decision to delay release of the exchange rate policy report has provided time for China to make up its mind. But with growing domestic pressures in the US, Geithner won’t have a lot more freedom to hold his decision back.

Some Chinese economists have advocated that PBOC should first hike interest rates before revaluing the currency. They argue that if the PBOC revalues the currency first, it could attract a more cash inflows, which might further boost asset bubbles. But hiking interest rates first also has its own problems. Increases in interest rates before currency appreciation would dampen domestic demand and hurt imports. Furthermore, this response in China would likely further exacerbate the external imbalance problem.

Hence, it is best to adjust the interest rate and exchange rate simultaneously. If the PBOC moves on both fronts now, both actions will serve in fighting the domestic risks of overheating and inflation. This also has the added advantage of not being seen as a move simply designed to accommodate American demands.


Did i read that right Kracker? Did that say tonight $5.26?
Thanks,lookin good.


TONIGHT 5.26!!!!!!!!!!


lmaooooooooooooooooo...yes donn it did..ya just have to read between the lines to see it

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