Comparison of Inflation, China and the US
ECON220: Principles of MacroeconomicsComparison of Inflation, China and the US
Inflation is a persistent increase in the price of different commodities without a corresponding change in quantity demanded. As such, inflation is a macroeconomic indicator used to measure economic performance of a nation. This research paper sets out to compare inflation in China and United States.
The Chinese economy is recorded as one of the strongest and fast growing economy in the world. In the last two decades, the economy has recorded a fall in unemployment and economic growth, but inflation persists. With the economy, engaging in vigorous policy and structural reforms, the economy has turn out to be resilient, flexible and well integrated within worldwide markets. The main objective of the Chinese government is to keep inflation as low as possible. Therefore, the country??™s policy makers will have to adopt inflation targeting monetary policy. Under this monetary policy, the target is to sustain inflation at a favourable range. The inflation target can only be attained through the Central Bank??™s periodical adjustment on the interest rate target. The economy will adopt a contractionary monetary policy where the amount of money supplied in the economy is reduced making the interest rates soar leading to low inflation rates. With the open market operations, the interest rate can be kept constant for a no significant change according to various economic indicators. According to the Bureau of Economic Analysis estimates, the current rate of annual growth rate of the real GDP in the year 2012 is estimated to be only 1 precent. This translates to 0.25 precent growth rate as the quarterly growth rate. This rate of economic growth is very insignificant compared to the 3.3 precent growth rate that was the experience in the last quarter of last year. The volatility of economic growth rate has left many people without employment and this is a major cause for concern. In addition, inflation is persisting with the rate of inflation ranging at 1.7 precent. (Mataloni, 2012).
Importance of inflation
The market forces determine inflation rates and as such, the economy faces the risks of uncertainty because prices fluctuate on a daily basis. Therefore, it brings confusion among importers and exporters since they are not sure of the exact price. In addition, it may act as an impediment to investment, and the economy is at risk of lacking investment both internal and foreign investment. The other risk is that an economy is vulnerable to high inflation rates, and as a result, an economy will face adverse economic times. Furthermore, an economy will be exposed to the risks of speculation; this will destabilize and damage the economic performance of the country. An economy will also face the risks of mounting deficits in relation to balance of payment deficits. Private spending leads to inflation, which affects aggregate demand, hence low employment creation rates and growth levels (Stock & Watson, 2007).
Peoples Bank of China as a monetary policy to revive and boost economic growth decided to cut interest rates to 6.06 precent by 25 basis points in the second and third quarter of 2012. The poor economic growth experienced in China is due to the slowdown in the United States and euro zone. The monetary policy was adjusted because there was a gradual ease in inflation pressures as indicated by low external demands, appreciation of renminbi, as well as home economy slow down. The Central Bank of China will also reduce the reserve requirement ratio by 50 basis points. The fall in consumer price index to 3.33% in 2012 as compared to a 5.4% in 2011 offers leeway for the Peoples Bank of China to relax its monetary policy as the local economy register poor performance. It is indispensable for the central bank to relax its policies in order to boost growth.
Furthermore, the Chinas economy in the last two years has experienced negative real interest rate. This implies that deposit interest rates should remain constant, but the loan interest rate should be cut. This will encourage investment and boost domestic demand (Chang & Lee, 2010).
Measures to Combat Inflation
Policy instruments are defined as the available options that can be utilized by the government to run economic activities. Instruments are classified as either monetary policy or fiscal policy. Fiscal policy refers to those actions undertaken by the government in relation to its level and composition of expenditure, borrowing and taxation with the main objectives being to spur economic growth, lower unemployment rate, manipulate growth and level of output and aggregate demand (Beechey & Osterholm, 2012).
Monetary policy refers to the actions pursued by the central bank of a country so as to regulate the amount of money supply in the economy. The actions can be either on interest rates or on exchange rates. The main objective is to check on the rate and level of expansion of AD (aggregate demand) in the nation. Specifically it is used to control the rate of inflation and unemployment rate. Monetary policy can be either expansionary or contractionary policy.
Therefore, a target is also referred to as an objective. It is the aim of any economic policy and it can be measured in reference to an economic variable like unemployment rate, growth of Gross Domestic Product (GDP), or rate of inflation. To achieve these targets we use policy instruments. A change in economic policy (instruments) used will led to a change on the other variable (the target). This indicates of the relationship existing among economic variables.
When inflation rates are higher than the expected, the central bank is likely to increase interest rates. This is a contractionary policy since it will ensure a just economy and a low interest rate. On the other hand, in the event of low inflation rates far below, the bank will respond by lowering the interest rate. This will increase the amount of money in circulation; hence, the inflation will be steadily increasing.
Monetary policy in an economy lies on the relationship between the total amount of money in circulation and the rate of interest in the economy. Monetary policy employ a number of tools in controlling the amount of money supplied and the interest rate to influence variables like unemployment, inflation, exchange rates and economic growth. Where only the central bank is vested with the sole power of issuing currency, the bank will have the power over the amounts of money that should be in circulation. With the ability to change the amount of money supply, it will also affect the interest rate.
It is essential for policymakers to come up with realistic announcements, and protest against interest rate targets since they are irrelevant and not essential in relation to monetary policies. When consumers and businesses consider that policymakers are devoted to keeping inflation low, they will expect prospect prices to be lower. In addition, when an employee anticipates prices to increase in the near future, the employee will find employment with high wages to counter for the increase in price. Hence, the anticipation of poor wages is indicated in wage-setting conduct between employers and employees. With low wages, there will be no demand-pull inflation and cost-push inflation since employees earn less and employers pay less respectively.
To reach the intended low inflation, policymakers should have realistic announcements. This means that private agents should consider that the announcements would indicate real future policy. When an announcement concerning inflation objectives is made and is not understood by private firms and customers, wage setting shall foresee high inflation level implying that wages will be elevated and inflation goes up. A lofty wage will augment a consumers demand-pull inflation and business cost push inflation. For this reason, if policymakers make incredible announcements concerning monetary policy, it means that the desired policy effects will not be achieved. Again, if policymakers suppose that private individuals and businesses expect low inflation, an expansionary monetary policy will be adopted where the extra gain per unit outweighs the extra cost of inflation per unit.
However, credible announcements are done in many ways. First is to set up an autonomous central bank with minimal inflation targets and no output objective. In this case private individuals and firms are sure of inflation being low since it is bench marked by the autonomous institution. This can be attained through incentives such as increase salary for the bank governor as a sign of the bank??™s commitment to its policy targets. These means that in any policy implementation process reputation of the business plays a very important role but it must not be interplayed with dedication (Zhang &Clovis, 2009).
Despite the fact that a central bank may possess a positive reputation based on its perfect performance in carrying out monetary policy, the bank may not have necessarily embraced any particular kind of commitment for instance aiming at a particular inflation range. Reputation also plays an important part in establishing how well would the target markets agree to the announcement of a certain dedication by the central bank to a policy aim but reputation and dedication should not be incorporated. In addition, in rational circumstances reputation of the policymaker concerning past policy options does not count, it is only the ideologies, public statements, professional background among others of the central bank head that matters. In fact, many economists have argued that to do away with any pathology in relation with the inconsistencies of time during implementation of monetary policy, the chief of the central bank ought to have a bigger aversion for inflation as compared to the rest of the economy. Hence the reputation of the Reserve bank of a nation will be tied on institutional arrangements other than past performances when private agents are anticipating on inflation (Conrad & Karanasos, 2005).
Inflation rate is a measure of economic performance of a nation. The macroeconomic policy specifically the monetary policy embraced by the central bank of the two nations in its policy and structural reforms has turned out to be fruitful. The countries have been able to combat inflation resulting to a steady economic growth. In the peak of global financial crisis the government of China has been able to avoid recession through its central bank firm adherence to its commitment to the monetary policy.References
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