Inflationary Pressures in the 1980s and 1990s

High inflation is almost always associated with rapid rates of money growth and large budget deficits, both of which were abundantly present in the People’s Republic’s early inflation experience.

Table 3.3. Inflation, Money, Budget Deficits, and Outputin the Post-Reform Era, 1979-2006

Sources: The consumer price data are the Great China Database (http://www.finasia.biz/tejonline/ tejonline.htm) and the 1998 China Statistical Yearbook (Table 9.1) - with pre-1985 data based on the “overall retail price index”; the money supply data are from the Great China Database and the International Monetary Fund's International Financial Statistics database (sum of series 34 and 35); the ratio ofbroad money to output is obtained by dividing the money supply data by gross domestic product in current prices from the Great China Database; the budget deficit figures and real output growth (based on constant price gross domestic product) are from the Great China Database.

have been damped.

The fivefold increase in the M2/output ratio between 1979 and 2005 enabled the government to obtain substantial seigniorage revenue from expansion in the real money supply. This is usually interpreted as evidence of rising desired money holdings as the Chinese economy became increasingly monetized. The early gains in the M2/output ratio could also represent a continuation of the repressed inflation phenomenon discussed earlier, however, with Feltenstein and Ha (1991), for example, suggesting that no significant trend toward higher real money balances during 1979-1988 remains if account is taken of the effects of repressed inflation. Yet the repressed inflation hypothesis becomes less plausible with the ending of the two-tier pricing system and a move toward a more market-based system of prices by the 1990s. The continued advance in the M2∕output ratio after the 1980s almost certainly reflects a voluntary increase in money holdings, and such rising real money demand is consistent with a more than proportionate response of money holdings to rises in real income, as well as to price increases, over the post-1990 period (Burdekin and Siklos, 2008).^[43] Revenue from real currency expansion reached an estimated 3.8% of gross domestic product in 1992 (World Bank, 1995, p. 125) and the level of the M2∕output ratio has remained above 100% since 1993. Although the rate of increase in the M2/output ratio slowed relative to the prior 1979-1993 pace, the M2∕output ratio still recorded an 88.5% advance from 1994-2003. The M2∕output ratio subsequently declined slightly in 2004-2005, falling from 188.5% in 2003 to 163.2% in 2005.

Even in the face of such seemingly strong appetite for real money balances in the early 1990s, the rise in M2 growth to 42.8% in 1993, followed by 34.5% in 1994, was accompanied by a surge of inflation above the 20% level.⁷ Although the officially recorded budget deficit remained low, representing only an approximate 1% share of output, lending by the People’s Bank of China for policy purposes (chiefly loans to loss-making state enterprises) added significantly to the government’s actual financing needs.⁸ Taking account of such lending, World Bank (1995, p. 28) estimates tied the jumps in inflation in 1988 and 1993 to a near doubling of the consolidated deficit to 6.4% of output in 1988 and another sharp jump to 8.9% in 1993. Atthesame time, sharp increases in the People’s Bank’s lending to the financial system were seen in both 1988 and 1992 (World Bank, 1995, pp. 53-54), consistent with the funding needs represented by off-budget loans - encompassed by the consolidated budget deficit but not the official, unadjusted figures. Wong, Heady, and Woo (1995, p. 28) offer even higher numbers on the Chinese government’s consolidated deficit, suggesting that it amounted to 7.6% of output in 1988 and rose above 10% by 1990-1991. The World Bank (1995, p. 39) argues that the People’s Bank’s “obligation to finance a persistent CGD [consolidated government deficit]... caused the repeated buildup of inflationary pressure in China” and accounted for more than two-thirds of the annual growth in reserve money over the 1987-1993 period.

The exchange rate reform in 1994, and depreciation of the official exchange rate discussed in Chapter 1, was another factor adding to infla­tionary pressures during 1993-1994.

the upward movement of prices that started with agricultural products in the fourth quarter of 1987 was spreading to other sectors;... sporadic panic buying appeared everywhere... [and] a negative growth rate of bank savings appeared in April [1988], indicating that the inflation expectation had begun to take shape.

relatively higher overall M2∕output ratio to a less developed financial sector and smaller range of investment opportunities than those available in other neighboring economies.

⁷ Baizhu Chen’s (1997) long-run money demand estimates imply that broad money growth needed to be held to 28-29% in order to keep inflation below 10% - assuming a 10% rate of real output growth.

⁸ Furthermore, under the Chinese definition of the deficit, debt issues are counted as part of total revenue. For consistency with the standard Western definition of the budget deficit, proceeds from debt issue should be subtracted from the officially stated budget balance (Wong, Heady, and Woo, 1995, pp. 23-25). This adjustment can only be performed through 1996, however, because official data on debt proceeds stopped being provided in

There were also major administrative price increases during each infla­tionary episode. Prices of pork, vegetables, sugar, and eggs were hiked by as much as 60% in April 1988 while, in 1994, food price inflation was fueled by a 40% rise in grain procurement prices (see Oppers, 1997, pp. 9-12). However, these administrative factors operated in conjunction with easier monetary policy and heightened deficit-monetization pressures.