The subtle consequences of inflation
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The Chinese economy has seen two months of rising inflation as measured by the official CPI numbers. In October, the CPI rose by 4.4 percent and then in November, by 5.1 percent when compared to the previous year's like months. Obviously, Chinese consumers have felt the uncomfortable effects of these accelerating price increases as they have gone about their normal shopping. These effects have been greeted with distain in the media. There is no shortage of articles that attempt to explain why there is Chinese inflation at this time, what should be done to slow it down and when this inflation will subside. All of these make for interesting reading. However, it may also be a good time to review why inflation is considered such a fundamental and nasty problem.
First, inflation attacks different sectors of the economy differently. For example, it is generally acknowledged that inflation for food during the past two months was several multiples higher than the official CPI rates. In addition, actual future inflation is hard to predict and it accelerates and levels off unpredictably.
In addition, once inflation gets well established in an economy, it is difficult to get rid of it. It feeds on itself because people get conditioned to expect more inflation in the future. If the government is to be successful in ridding the economy of established inflation, it must inflect painful measures to change people's habits and expectations. Therefore, the political will to really fight inflation is hard to come by – either in China or the U.S.
Second, it is fair to say that inflation arbitrarily and capriciously redistributes wealth. Here are two examples. Retired people on fixed incomes suffer wealth losses due to high inflation, but workers who get pay raises that exceed the inflation rate actually become wealthier because their purchasing power increases. During times of high inflation, the owners of fixed-income securities lose wealth while many owners of common equity securities enjoy wealth increases because the companies they have invested in can increase the prices of the products they sell by more than the general rate of inflation. Arbitrary and capricious redistribution of wealth is unappealing to almost everyone.
Third, and perhaps the most egregious effect of inflation, is it makes decision making in all areas of the economy more difficult; thereby increasing the probability that a manager will make the wrong decision. Wrong decisions within an economy harm everyone, including international entities. Perhaps another example is called for. Suppose a manager is trying to decide between new diesel powered equipment and new gasoline powered equipment and predicting the future cost of the respective fuels is critical to making the right decision. In a high inflationary environment, the manager may select the equipment powered by the fuel that increases in price more in the future and thus, his or her decision is wrong. This represents a misallocation of resources and the proper allocation of resources is essential to improved standards of living in the domestic economy as well as all over the world.
In conclusion, the recent bout of increased Chinese inflation has more pronounced, but maybe more subtle, consequences than the mere distastefulness of rising prices for consumers.
The author is a columnist with China.org.cn. For more information please visit: http://www.china.org.cn/opinion/node_7078635.htm
Opinion articles reflect the views of their authors, not necessarily those of China.org.cn
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