China's Consumer Price Index (CPI) jumped to a 28-month high of 5.1 percent in November, raising concerns among consumers, investors, economists and the government. The questions the public is asking are: What is China's real inflation rate? What should the policy response be? Will prices continue to rise next year?

Experts as well as consumers question the accuracy of official statistics. The reason is simple. The inflation rate as perceived by consumers is much higher than the official figure. Nowadays, it seems, inflation lurks wherever consumers spend their money. From routine purchases to brand shopping, from chain stores to street stalls selling baked potatoes, consumers see prices are going up. No wonder they question the CPI numbers. But is seeing the same as believing? Probably not.

Prices of everyday items like clothing, foods, drinks, sheets and blankets have increased sharply. Consumers get direct pricing feedback from their daily shopping trips. They see the rising prices, goods getting more expensive and they feel the effects of inflation. On the other hand, the official methodology for calculating the CPI census covers 226 geographic areas (80 counties and 146 cities) and 251 groups of products. In total, about 600 "national items" are used to calculate the all-China CPI. But the hard truth is that the rise in food prices is about 5 times that of the official composite CPI.

What should the policy response be? Monetary policy has the potential to control inflation, but has limited effect in a period of economic stimulus. Raising reserve ratios and interest rates can narrow the gap between nominal and real interest rates, but the government has already poured too much money into the economy, and it may be too hot to cool down. China's currently money supply, as measured by M2, is about US$10 trillion, while that of the U.S. is about $8.8 trillion. And it is worth mentioning that the size of the Chinese economy is about one third that of the U.S. This suggests that too much money is circulating in China.

It is a tough time for the government. There are many layers of conflicting interests. Inevitably, all will be involved in government policy responses. There are no easy options. Raising interest rates may cause an inflow of overseas money; constraining the money supply may slow economic growth; pursuing restrictive policies too quickly may lead to deflation; and allowing a more rapid appreciation of RMB may cut profit margins in the export sector.

China has a strong government. The Chinese people still rely heavily on government involvement. Both businesses and consumers want the central government to have an effective influence on business. It is for this reason that the Chinese government can justify regulatory intervention, and changes in China's inflation rate can be sharper than seen elsewhere. Indeed, we recently saw prices cuts on many perishable items – fruits, vegetables, eggs, poultry and meat. Government price controls contributed to these decreases. But what about businesses like McDonald's and Starbucks? Would the government be able to regulate their prices?

Will the CPI continue to go up next year? The most likely answer is "yes." The CPI will likely continue to increase at a rate of 5 percent for at least the first half of next year. And inflation is not likely to fall without government intervention. Lowering the inflation rate is at the top of the policy agenda for 2011. As noted above, the money supply is already too high, but this may get worse if there is a net inflow of foreign capital into China. If large numbers of foreign investors continue to speculate on RMB appreciation, the inflation rate will remain high. Whether the government policy can effectively manage speculator-led capital inflows is uncertain.

According to the 2010 Blue Book recently published by the Chinese Academy of Social Sciences (CASS), Chinese citizens' overall satisfaction with life is declining. This means a lot to the Chinese government. But China's economy and policy makers are still on a learning curve, and even though the government can control the money supply, the central bank may have difficulty in discerning exactly what to target.

Looking ahead to 2011, we can expect to see developments in the area of social welfare provision, which will help with the implementation of an effective policy for fighting inflation. Although the government has pledged to control inflation, policy responses will not work effectively unless they are accompanied by appropriate income distribution and social security measures. Public feelings must be taken into account.

The author is a columnist with China.org.cn. For more information please visit:

http://www.ccgp-fushun.com/opinion/node_7075405.htm

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