THE PRICE OF A PIG Editorial
Thursday, September 13, 2007
These are hard times for lovers of China's meatier regional cuisines. A 49 per cent year-on-year jump in meat prices and an 18 per cent rise in broader food prices led to a 6.5 per cent rise in the consumer price index for August. The manner and degree of China's inflation problem is hard to judge, but as prices rise, the case for exchange rate appreciation only gets stronger.
The price of a Sichuan meal has been affected by everything from floods to animal disease to drought in Australia. Leave food out and inflation does not look so bad: a rise in the CPI of only 0.9 per cent. But this is not satisfactory, because food prices matter in a still-developing country such as China, and because the CPI is a poor guide to the price level anyway.
Fewer Chinese are destitute, but a great many are still poor, and food is an important part of their total consumption. Food inflation far in excess of wage growth translates to a dramatic fall in their standard of living. That has political consequences: it breaks the unwritten covenant that China's unelected leaders will deliver prosperity in exchange for their power. It has economic consequences as well: migration to the cities, where food has to be paid for, becomes less attractive.
The CPI, meanwhile, does not capture the full extent of inflation. Many of the prices it measures, such as energy, are government- controlled. Others, such as the considerable cost of an education, carry less weight than they ought to.
China does have an inflation problem, and it needs to find workable policy tools to control it.
Interest rates are having little effect. With the one-year benchmark lending rate at 7.02 per cent – only half a percentage point above the headline CPI – China has minimal real interest rates. The People's Bank of China should raise rates further and faster, even though this channel has a limited effect on demand. It should also continue to raise savings rates, still only 3.6 per cent for one year, faster than lending rates, in order to entice funds out of the overheated stock market.
Further increases to bank reserve requirements make sense in order to constrain the growth of credit. There is a limit to how many low- interest deposits the banks can be forced to hold, however, without damage to their profitability.
The best policy instrument is the exchange rate. Allowing faster renminbi appreciation would damp down imported food prices and reduce accumulation of foreign exchange reserves (thereby reining in the domestic money supply). To keep prices down, China needs to let its currency go up.
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