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Tuesday, June 10, 2008

China's monetary policy still not tight

China's real interest rate (interest rate minus inflation) is still negative (see chart below), despite the multiple increases of bank reserve ratio recently.




(click to enlarge; source: EIU, author's own calculation)


To fight inflation and not to repeat the "great inflation" (leading to deflation later, the hard landing scenario) in mid-90s (see chart below), China's policy makers need to raise interest rate quickly. And this should be done sooner than later when inflation rate is still below double digit. The temptation to allow for inflation to go even higher in order to accommodate economic growth (the so called "go-stop" policy) is dangerous and should best be avoided.




(click to enlarge; source: EIU, author's own calculation)