South-Western College Publishing - Economics  
Chinese Success, Fast Growth - Slow Inflation
Topic Developing and Transitional Economies
Key Words Inflation, and Monetary Policy
Full Article

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Reference ID: A158368732

News Story The numbers are out on China and once again the Chinese economy grew at a record rate. Latest reports indicate that its economy grew by a whopping 10.7 percent in 2006. This is the fastest rate of growth for the economy in more than a decade. This was the fourth consecutive year of double-digit economic growth and the strongest year since the economy grew by 10.9 percent in 1995.

"This is pretty impressive," said Shen Minggao, an economist in Beijing for Citigroup. "I'd say 2006 was about the best year in a decade - fast growth and low inflation.

The problem with all this success is the potential that is building for economic problems in the future. "Right now, the economy is growing at the upper limits of what is acceptable," said LI Lianfa, an economist at Peking University. "The government is facing a lot of challenges."

Double digit growth such as that experienced by China often leads to inflation and policies aimed at cooling the inflation can also cool the economic growth. Even though the Chinese reports moderate inflationary levels, they are also showing their concern by engaging in traditional monetary policy.

In an effort to cool an overheated economy, the Chinese Central bank has raised interest rates by increasing reserve requirements. This move slowed some fixed asset investment in the later part of 2006 and moderated growth in the final quarter. The higher interest rates caused by the increased reserve requirement ratio restrict lending and places a damper on investment. With less investment the economy does not grow so fast.

Right now, it appears the government is determined to keep the economy revving but it also wants to prevent anything, such as higher prices, from spooling the big party in 2008 when Bejing plays host to the Olympic Games.

Questions
Discussion Questions:
1. Define and discuss the reserve requirement.
2. Discuss how increasing the reserve requirement can have a negative impact on economic growth.
Multiple Choice/True False Questions:
1. A government induced increase in interest rates will cause businesses to invest more.
  1. True
  2. False
2. The other two tools of monetary policy available to China are changing taxes and changing government spending.
  1. True
  2. False
Source David Barboza, "China Says Its Economy Grew by 10.7% in 2006, With Little Inflation", The New York Times Online, January 26, 2007.
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