Deflation in China

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By Dzhingarov

China is defying global trends of rising prices with consumer price inflation becoming negative last month and producer costs falling consistently over time.

This stems from consumer spending cuts and property market decline. This could potentially cause consumption levels to decline further and companies reduce production and investment accordingly.

Deflationary pressures

China is struggling to break out of a deflationary spiral. Consumer prices dropped for the first time since 2009 in January and industrial profits have seen sharp decreases. Deflation can be harmful for an economy’s development by leading to reduced consumption and investment, increasing government debt repayment difficulty and making monetary policy stimulation harder for central banks to manage.

Deflation can result from various causes, including falling wages or recession. Consumers might anticipate that prices will keep on falling or businesses might reduce production costs to save costs; all these can have long-term ramifications on an economy’s health; prolonged deflation can even lead to depression.

Economists have expressed concerns that China could be headed into deflation following consumer price inflation’s drop between February and March of 2023. China accounts for 35% of global nominal GDP and is one of the world’s biggest economies; should deflation take hold there it could trigger disinflation elsewhere – including the United States and Europe.

China is currently facing deflationary pressures as a result of several factors. People saved during the pandemic to ensure they could afford goods when restrictions on spending were lifted, thus decreasing demand and ultimately leading to lower prices for goods and services. Furthermore, reduced economic activity has caused companies to reduce production costs in order to remain competitive; globalization allows businesses to operate across borders more easily and could lower prices with cheaper production costs elsewhere in the world.

China’s policymakers have attempted to reverse the trend by lowering interest rates and increasing liquidity. Unfortunately, however, their monetary policy may no longer be working effectively; one way is raising people’s inflationary expectations which helps stimulate demand; another strategy would be increasing government spending while decreasing taxes which increases economic demand overall. China needs to find an equilibrium between all these policies in order to sustain higher inflation while preventing deflation.

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Symptoms

Consumer prices in China had their first decline in over two years in July – signaling possible economic trouble ahead. NPR’s Steve Inskeep spoke with Zoe Liu from the Council on Foreign Relations about what this could mean for individuals as well as globally.

Zoe, welcome to the program.

Deflation should make things cheaper for consumers to purchase items, which can be seen as beneficial if prices have decreased due to competition or decreased production costs. Unfortunately, however, people consuming less can lead businesses to reduce investments or even implement layoffs as revenue drops off significantly.

One major worry is that, with more people cutting spending, businesses could stop investing in new products – ultimately leading to recession. Furthermore, deflation makes debt repayment more costly, leading consumers and businesses to default more on payments which causes even further deflationary spirals as spending freezes further adds up and debt default rates increase again leading to further deflation and so on.

China’s deflation problems are compounded by various factors, including its housing market collapse and weakening exports, but nation’s leaders have pledged to increase fiscal and monetary stimulus to combat this challenge.

Consumer prices rebounded slightly this February due to Lunar New Year demand, while factory gate prices continued their steady downward spiral for 17 straight months – suggesting China could soon face long periods of deflation which could ripple throughout the global economy and impact investors in Chinese stocks. Neda Afshar contributed this report and can be followed on Twitter @NedaAfshar or by following NPR’s Economics Team @NPReconomics or Facebook; these team will produce in-depth journalism that illuminates this dynamic economy that affects people’s lives! NPR’s Economy & Business Team is dedicated to producing in-depth journalism about changing economies that affect lives – all this, from China, to business news events like trade agreements that shape up or affect us daily lives!

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Causes

China has enjoyed years of remarkable economic growth. But its transition from manufacturing-led growth to more consumer-driven economic activity has resulted in deflationary pressures.

Deflationary pressures often stem from reduced demand for goods and services by consumers who opt to save rather than spend their money, leading businesses to offer reduced prices which further bring prices down in a downward spiral. Deflation can often accompany recession, leading to lost trust among both consumers and investors which further diminish economic activity, creating a vicious cycle until an economy recovers itself.

China’s deflationary pressures are driven by various factors, including the collapse of its property market, consumer spending slowing and rising debt levels for local governments. Furthermore, many Chinese consumers have seen real estate values decrease with this collapse, leading them to experience wealth reduction which reduces spending potential among Chinese households and makes spending less likely.

China’s high interest rates and restrictive monetary policy make borrowing money difficult for businesses, which has inhibited economic development.

Another factor driving China’s deflation is a shift away from exports. As foreign markets become more competitive, companies may opt to reduce prices to maintain or gain market share – leading to deflationary pressures in China’s products.

Geopolitical tensions have also had a profound effect on the economy. Russia-Ukraine conflict has increased global uncertainty, which can have adverse repercussions for business activity. Meanwhile, Western countries have begun de-risking their ties with China due to territorial claims in South China Sea by Beijing.

Even with these challenges, China still stands a chance of breaking free from deflationary trap. To do so, China needs to implement policies which stimulate domestic consumption and investment – such as increasing government spending, lowering taxes or loosening monetary policy – so as to promote domestic consumption and investment growth and return rapid economic growth. By taking such steps, China could avoid prolonged periods of deflation and achieve rapid economic development once more.

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Prevention

China’s deflationary pressures are mostly driven by domestic issues such as real estate slumping, weak investment and lower exports; however, an extended period of deflation could have global repercussions; since China produces many goods sold across borders, their lower priced goods could flood international markets and push down prices there, potentially cutting company profits and consumer spending while undermining employment prospects.

Deflation can be a vicious cycle: by decreasing purchasing power and thus demand, purchasing power decreases, leading to decreased wages which then reduce consumption, driving prices lower even further, leading to further unemployment which further decreases demand. As the decline in purchasing power leads to additional unemployment resulting in further reduced demand and production stagnating and eventually recession setting in, deflation becomes difficult to break out from. It often has its origins in long-term trends like low economic growth or productivity levels that become entrenched over time.

One way to combat deflation is through increased consumption, which stimulates production. This can be accomplished by encouraging more spending among individuals or by changing government policies to be more consumer-friendly; such as providing tax breaks on consumer spending or increasing social welfare benefits. Another effective strategy against deflation involves increasing investments and spending on education, technology and infrastructure projects which will lead to productivity increases that lead to inflationary rates rising back up again.

Reform of the banking system to limit financial institutions to lending money only to productive companies is another long-term solution, although such changes will take time to implement and may only have limited immediate effects.

China’s central bank should continue monetary easing to ease deflationary pressures and increase fiscal stimulus, helping boost economic activity and decrease unemployment. But these measures alone won’t do the trick – China needs to undertake reforms that lessen reliance on real estate and infrastructure investments for economic growth; though this will take time and effort, it is imperative if deflationary pressures don’t become worse.