The tie between economic growth and the role of inflation has been of interest to the economist, especially now in the light of the global financial crunch. The emergence of new and rapidly growing economies has presented economists and other interested parties with the opportunity of analyzing economic phenomena, more so in light of the rapid technology changes and increasing globalization. The growth of the Asian economies, more specifically China and India have allowed the examination of interesting economic phenomena and put to the test classical and neo-classical theories of economics.
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Phenomenon of inflation
Inflation has been a phenomenon that has been of great practical and academic interest. The effects and causes of this activity have been documented for a long period. How it affects growth, is of particular interest. According to traditional economic theory, inflation can be an indicator of good economic growth, when in small amounts and if the economy has not reached full employment. Here, though it causes an increase in the price level, it causes a subsequent increase in the national income level, indicating growth in the economy. In the case of full employment, inflation merely causes an increase in the price level without causing an increase in the national income. This is when inflation is damaging.
Inflation in China
In China, inflation is measured chiefly using the Consumer Price Index (CPI) (Keidel, 2007). The inflation trends must be examined with the knowledge of the reforms era. This era was a period in the economic history of China where the government initiated the liberalization of the economy. Inflation in this period was only felt by the general economy and not the micro-economic players (Liou, 1999, 63). It is important to note that the people in the economy were subject to government-controlled prices and therefore were cushioned from price hikes as the government maintained artificial price levels (Liou, 1999, 63).
However, inflation was felt after this period by the general populace. The increase in investments coupled with an unstructured policy framework saw inflation increasing in the economy (Liou, 1999, 64). The investment levels put against the inflation levels during this early period show a positive correlation (Park, 2003, 255). Liou (1999, 63) states clearly that the investments were mostly made by government agencies and state corporations.
In the early part of China’s growth spurt, therefore, the inflation was driven by an increase in consumer demand and unregulated government expenditure. In my analysis, the two factors interplayed to give rise to increased output. However, the inflation levels could have been reduced if there was more economic discipline and regulation practiced. Later on, though, the government put in place strict measures to control the inflation levels.
The inflation measures put in place were tight monetary control measures (Park, 2003, 254). Structural elements such as banking regulation were also put under reign, especially after the 1993-94 inflation rise. Skeptics are seemingly harsh, however, stating that the government has continuously faulted in controlling inflation in time, necessitating big harsh steps to control the same (Keidel, 2007). Such steps include forced reduction of demand and investment that results in layoffs and unemployment. This is especially worsened by the fact that the economy is not more affected by internal demand than export demand.
A reduction in the economic demand means that there will be an economic slowdown (Keidel, 2007). In contrast, though, the low inflation rates that have characterized China’s economy in the early part of 2009 are proof that the policies in place can contain the inflation beast, even in the light of a global crisis caused by energy prices in 2007 and food prices in the past year (Ary, 2009).
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In summary, the inflationary trends of the Chinese economy have a cyclic twist to them. Inflation follows growth due to increased spending and investment. The government uses contraction monetary policy to control it. When economic growth slows, the expansionary policy is adopted causing growth and setting the cycle off again. Apart from growth, another instigator of inflation is food (Ary, 2009; Keidel, 2007). In my assessment, the large population and restrictive policies practiced by the government preventing imports of certain foods results in a very sensitive food market. If the production is tampered with, such as in 1994 with the floods, inflation follows and spreads quickly to the other arms of the economy (Keidel, 2007).
Inflation in India
India, like China, also has experienced growth-induced inflation. The rapid economic growth, especially in recent times has led to this phenomenon. As stated earlier, the increase in economic growth triggers growth-related inflation which is normal and expected. There, however, lie a few problems with India’s inflation calculation methods that do not tally with the modern conventional methods of inflation measurement.
First, inflation calculation in India is done using the Wholesale Price Index (WPI) (Ridiff, 2007). Critics state that this measure is inadequate as it does not recognize the importance of the individual consumer in the measure of the same (Ridiff, 2007). Also, this measure does not recognize the current goods consumed by the populace as it has not been updated for a long time (Ridiff, 2007). Experts state that the system should change to the more conventional CPI measure. This though, is not very suitable for India as the reporting system would not be able to accommodate the high speed of information gathering and calculation required for this measure (Ridiff, 2007).
The inflation pattern for India has been somewhat stable (Rajan, 2005, 124). The fluctuations can be divided into three periods as shown by Bhalla (2000, 39). Between 1988-81 inflation has been around 7%. The second period ranged between 89-95 where inflation stood at around 10% then fell to 5% later from 1996 (Bhalla, 2000, 39). In my assessment, the rise may have been caused by high growth coupled with inadequate structures in place to check the inflationary levels. The stability achieved in this phase, though, is an achievement that was only possible due to the high level of macroeconomic discipline established in the system.
The government has over the years successfully used monetary policy to effectively control this phenomenon (Riddiff, 124). Another reason presented for the relatively low and stable levels is the effects of globalization (Bhalla, 2000, 43). By opening up the economy, there are fewer barriers to trade and fewer controls that would lead to inflationary pressures. These real sector reforms are part of the reason for the relative stability.
In the Indian economy, food prices also drive up the rate of inflation, just like in China. However, the global increase in the cost of energy contributed heavily to inflation levels in the last 2 years especially. The increase in inflationary levels witnessed in 2008 at the level of 7% resulted in a slow-down of the economic rate of 8.7%, which is still impressive (BBC, 2008). However, the inflation rates still bite, especially the large population of the poor (Callen, 2001, 105).
India’s very large disparity in economic classes results in an uneven distribution of wealth and very low-income rates to the lower cadre workers. If there is inflation, the poor are especially hard hit since their earnings are not large enough to cushion them from the effects. Inflation would result in the price of necessities, especially food, hiking, resulting in the inability of the poor to access the resources.
In conclusion, the effects of economic growth are reflected in the inflation levels in both economies. The problem of overheating, especially in light of foreign investment is a real problem that especially China faces. In the two countries, the category of people bitten most by uncontrolled inflation varies. While in China it is the town populace that is the loser due to increased food prices, in India the poor among the population is bitten hard by the effects of the price increase.
The relative stabilities of the two economies have also not been equal. While in India the inflation rates have been somewhat stable from the 80s, in China, they have seen spikes. This difference may be attributed to the difference in reaction time by the two governments, as cited by Keidel (2007). It is important to note, however, that the growth rate of China has not been compromised by these spikes in the long run. China has seen greater growth than India, though this as seen has not been influenced by inflation changes as one would expect.
Ary (2009) Inflation in China Slowed In 2009. Web.
BBC News (2008) Food Prices drive India Inflation.
Bhalla Surjit S (2000) New economic policies for a new India, Har-Anand Publications.
Callen Tim et al (2001) India At The Crossroads: Sustaining Growth And Reducing Poverty, International Monetary Fund.
Keidel Albert (2007) China’s Looming Crisis- Inflation Returns. Web.
Liou Kuotsai Tom (1999) Managing economic reforms in post-Mao China, Greenwood Publishing Group.
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Park Yung (2003) China, Asia, and the New World Economy, Oxford University Press.
Rajan Rajiv et al (2005) Re-emerging India: a global perspective, ICFAI Books.
Rediff (2007) How India Calculates Inflation. Web.