What causes inflation in China Essay Example | Topics and Well Written Essays - 1500 words

What causes inflation in China - Essay Example Inflation is an economic phenomenon in which prices of goods and services increase gradually over a period of time. It is one of the most important economic problems facing by majority of the countries at present. Even developed countries and rapidly emerging countries are not free from the problems generated by inflation. China is the most rapidly developing country in the world at present. Yet, â€Å"China's inflation rate hit a 10-month high in February, as Lunar New Year festivities drove up food prices. Consumer prices rose 3.2% from a year earlier, with food prices up by 6% (China inflation rate hits 10-month high in February, 2013). This paper analyses the reasons of inflation in China. Causes of inflation in China Even economists are not unique in their opinions about the reasons of inflation. In other words, there are plenty of reasons for inflation in a country. However, two economic theories; Demand pull and cost push inflation theories explain the reasons of inflation co mprehensively. Demand-pull inflation occurs when demand for a good or service increases so much that it outstrips supply. As demand increases, sellers start selling out of the product, and frustrate potential customers. Their next step would be to produce more. However, if supply is constrained, their next step would be to raise prices, creating inflation (Amadeo, 2013). Demand pull inflation is illustrated in the figure given below. Demand pull inflation is a case in which too much money available in the market whereas the availability of goods or services is less. In other words, in economies with demand pull inflation, demand for goods and services will be increased whereas the supply decreased. As a result of that price will be increased. (Monetary Policy - Inflation – Causes, 2012) Demand pull inflation occurs mainly in growing economies. Since China is one of the most rapidly growing economies, demand pull inflation occurs quite frequently. â€Å"China’s broad m oney supply more than doubled in four years, reaching 97.42 trillion yuan (US$15.66 trillion) by the end of 2012, according to central bank figures. Economists blame the unprecedented growth in credit for the inflation and asset bubbles† (Zitan, 2013). Centran bank of China is printing excessive currencies in recent times in order to pump more money into the market and to increase the economic activities. As a result of that asset bubbles are creating major industrial sectors, like real estate industry in China. Asset bubble is an economic phenomenon in which the prices of assets increase sharply. In other words, asset bubble increases the prices of commodities beyond its actual or realistic price. When prices of a commodity increases beyond its actually value, the possibility of sudden collapse of its value cannot be ruled out. In short, when the government pumps more money into the market the value of the commodities increases beyond its actual prices and thereby causing inf lation. Credit or money supply is essential for a country’s economic growth. It has direct relationships with the gross domestic product (GDP) of a country. Economic activities in a country can be sustained only with the help of adequate money supply. However, excessive money supply brings more harm than good. Money supply is usually keeps a ratio of 1 to 1.5 with GDP in developed countries. However, in China’s case, this ratio reached an all-time high 1.88 in 2012 (Zitan, 2013). In terms of credit creation, no country seems to be anywhere near to China. As a result of that asset bubbles or economic bubbles are common in China. Loans made by Chinese banks in recent times are extremely higher compared to that in the past. Thus, Chinese people are getting plenty of money in their hands for purchasing goods and services. When the purchasing abilities of the people increase, economic activities will also be increased. At the same time, price hikes will also take place as a result of the pumping of more money in to the market. Cost push inflation