QUANTITATIVE ANALYSIS OF INFLATION ISSUE IN CHINA
Xu Dies Bank of Chine, Shanghai Branch
ROOM 1705 RUT JIN BUILDING
205 MAO MING NAN ROAD, SHANGHAT
Wan Xuemei; Shanghai College of Printing
& Publishing, PLR, China
397 NET JTANG ROAD, SHANGHAT
Yan Guangle: Shanghai Institute of Mechanicat
Engineering, P.R. China
P.O. 231, 516 JUN GONG ROAD, SHANGHAT
ABSTRACT
It is no doubt that China now is facing a challenge of inflation: quick prices rising, over
issued monetary, rapid growing total social demand and unsufficient production supply...
The present paper studies the inflation issue in China in terms of the macroeconomic
theory by system dynamics, in order to find the fundmental causes and the self-promoting
mechanism of inflation in China, In thts paper, factors of total social demand, monetary
issue, etc, have been qualitatively and quantitatively discussed, some policy tests have
been made, and finally the new viewpoints and suggestions which will help to cut down
inflation are put forward, It is a new test to study inflation by system dynamics instead
of by regression or curve fitting,
I. INTRODUCTION
From the results of our earlier studies of monetary issue in China by system dynamics, we
find:
First, the grice level ¢ price index ) shows s strong exponential growing trend,
especially in recent years this trend appears more obviously,
Second, in recent years ( expect 1982 >, monetary supply was ohviousty great than monetary
demand,
In view of the above-mentioned facts, we predicted: a stronger inflation would take place
in China, As we expected, in August of the same year ¢ 1988 ) the violent wind of rush
purchase and rush bank-cashing seeped all sides. Chinese economy was puzzled by inflation,
The inflation was studied before mostly hy regression, curve fitting and qualitative
methods, Of cause the ahove methods could do something in some way. But there still are
sone shortcomings, We know inflation is an extreme complex problem in real macroeconony,
It is influenced by many interconnected and interacted factors, To this end, the study of
inflation only by regression or by qualitative method is felt quite helpless,
System dynamics is good at dealing with high-order, multitoops, nonlinear and dynamics
systems. On the base of our research work of monetary issue, we try to explore the causes
and the mechanism of inflation in China, and then put forward sone new viewpoints and
suggestions by which the inflation would he cut down,
I], THEORY ANALYSIS
1. Inflation
Economists have many different viewpoints to inflation so far, We consider inflation is a
kind of monetary phenomenon, It means over-issued monetary results in quick prices rising.
The former is cause and the latter is effect.
2.Monetary Supply and Monetary Demand
Monetary Demand
Keynesian economical theory divided monetary demand into three parts: transactive demand,
precautionary demand and speculative demand,
a.Transactive demand Mdj
Mdj/P = f1¢ NI,P > C2-bD
with df1/dNI > 0, dfi-dP <0
where NI stands for national income, P stands for price level.
b. Precautionary Demand Ndy
Ndy-P = 12 CNLP > ca-ed
with df2-dNt > 0, dfadP <9
c, Speculative Demand Mdt
Mdtyp = 13 CNR) Ce-3)
with df3/dNI > 0, df3/dR <0
where R stands for interest rate,
Then the total annaul monetary demand Md becomes:
Nd = Ndj + Ndy + Mdt ca-4d
In fact, Mdj and Mdy have something to do with consumption and Mdt is concerned with
investment, By the consideration of this, monetary denand can be expressed as the sum of
the two parts, consumption demand and investment demand.
NEP = C10 NLP) + £20 NLP) + £3¢ NLR)
= FICNLP > + Fac NLR) ca-5)
with @FIC NIP) ANT >0, FIC NLP) AP <0
aPC NLR) ANT > 0, AF2C NTR AR <0
where FIC NIP ) = fl¢ GIP ) + fac NI,P ) stands for
consumption demand, and F2¢ NI,R ) = £3¢ NI,R ) for investment demand,
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2Monetary Supply
Monetary supply is governed by the central nationat hank, symbolized by Ms, The annual
monetary issue can be regarded as its increment, Similarly, monetary supply can also he
divided into two parts, consumption supply and investment supply corresponding to
consumption demand and investaent demand,
3)Difference between Monetary Supply and Nonetary Demand
Obviously, there almost surely is an imbalance difference hetween monetary supply and
monetary demand because of various reasons, This difference is symbolized by DISCM,
In maroscopic range, the two factors of price level and interest rate are concerned with
DISCM, Price level is directly affected by DISCM, and interest rate is a leverage
adjusting DISC,
TIL, MODELING
According to the previous analysis, we created a system dynamics model to our interest
problems, The causal loops of the model is exhibited in figure 3.1.
In terms of the macroeconomic theory and the actual situation of China, we adjusted and
tested our model repeatedly, Finally we find a more suitable model structure. The main
equations are listed as follows: ©
ANT dt = Kt * NE 5 ee
dPD/dt = Al * NT - Bi EXP ¢ Bil P > Cr- 2d
DISCP = PD - PS Co: Mae
dP/dt = Fi x DISCM + Et * DISCP + C1 x P C34 >
dIDdt = A2 * NI - Ba EXP ¢ B22 R > C3-5)
DISCI = ID - IS ca*6)
dR-dt = F2 * DISCM + Et * DISCI G97
‘MD = K2 PD x P + K3 ID x P ca-8)
DISCM = MS ~ MD yay
Where PD stands for production demand, PS for production supply, DISCP for difference
between PD and PS, IS for investment supply, ID for investment demand, DISC! for
difference between ID and 1S, MD for monetary demand, MS for monetary supply, DISCM for
ference between MS and MD, the others are constant, The symbols have same meanings in
ure 3-1.
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Figure 3.1 Causal Loop Diagram
VI, CONCLUSIONS AND DISCUSSIONS
1.Contrary to Effective Demand Rute
Keynesian economical theory indicates: there surely exists a difference between
the demand of various factors including work force and social potential capability,
The demand of production factors are always less than the supply, The effective demand is
unsufficient,
However, we found an interesting problem in our model simulation, Since the start of the
reform in Chine, the effective demand, either consumption demand or investment demand, has
exhibited strongly growing trend, Demand is inflative instead of unsufficient. (See Figure
41d
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Figure 4.1
During the first period of Chinese reform, in order to break the rigid way of panning
economy system, a series of new policies were formulated. The critical points were:
1To raise the workers’ and staffs’ working enthusiasm by money awards and allowances,
2)To give full play to the producing enthusiasm of localities and enterprises by increase
their functions and powers,
It was expected that by taking above steps, the productivity could be raised, the
production output could be increased, the people’s living standard could he improved,
these reform policies in some way achieved good results in stimulating economical
development, But because of the disadvantages in old economic systen of China, these
reform policies at the same time hid inflation danger in the process of transforming
product economic mode into commodit one.
TI
TINE T2 TIME
Figure 4.2 Figure 4.3
One factor of inflation is consumption expanding, We can see from Figure 4.2 and Figure
4.3, that after TL the total consumption demand exceeds the supply, and after T2 so does
the increase rate of consumption. What do these result from? We consider that the original
goal of the reform is to raise effection by giving awards to the advanced, However in the
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case of no actual work force market and no strong market adjust of income level,
remarkable difference income level can only result in the compitition of income and money
reward Instead of effection, Meanwhile, hecause of the unreasonable price system,
management state may not factually inflate management level for enterprises so as to tead
to the compitition of income, Finally the increase rates of income and consuaption Level
exceed that of labour productivity.
Q aq 10
10 1S
| |
i i
13 TIME + TIME
Figure 4.4 Figure 4.5
Another factor of inflation is investment expanding, We can see from Figure 4.4 and Figure
4.5, that after T3 the total investment demand exceeds the supply, and after T4 so does
the increase rate of investment, What do these result from? We consider that whith the
function and power increasing localities and enterprises possess more authorities of
investment and more financial resources in addition to the interest rate is lower than
normal, The most interesting thing for them is how to obtain financial allocation and bank
credit instead of investment gain, Because of the departmental selfishness of localities
and enterprises and unreasonable credit system, excessive investment demand intensifies
inflation,
2.Factor of Bank System
There are many reasons for inflation in China, Consumption expanding and investment
expanding are inherent force, From the results of our model simulation, the investment
expanding is more dominant. Bank should be reponsible for the external tendency of
investment resources, Sustainedly excessive monetary issue makes price level quick rising.
In this process bank has added fuel to the flanes,
Here we must point out, that in terms of the actual case of China the creation of such a
situation is attributed to the disadvantages of system. As the central bank, the People’s
Bank of China is subordinate to the State Council, It is an administrative organization of
the government, No doubt, its action would surely obey the macroeconomic policies of the
government instead of protecting monetary, So bank system can not play the role of
adjusting and controlling the macroeconomics, Facing inftation, bank feels powerless.
Oppositely, bank may promote inflation, This can be illustrated by Figure 4.6.
little + raise interest = Jeut down
inflation rate level inflation
a, Normal Case
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abjective econonic policies]
governnent interfering
little + [maintain + [investment
inflation original level further expanding
increase |_+ increase of the difference | +
of inflation hetween denand and supply
b. Now The Actual Case In China
Figure 4.6
To this end we suggest the bank system reform be speeded up, and hank system be separated
from state finance and state administration, Bank system should take the important task of
adjusting macroeconomics and controlling inflation,
V, REFERENCES
1, Wang Qifan, System Dynamics, Tsinghua Univ, Press 1988.
2, Samuelson, Economics, Nc Graw-Hilt Book Company.
3. Edward J, Shapiro, Macroeconomic Analysis, Harcourt Brace
Jovanovich, Inc. 1978.
4, Lloyd G, Reynolds, Macroeconomics Analysis and Poticy,
Richard D, Irwin, Inc. 1979.
State Statistical Bureau, China 1987’s Statistical
Almanc, China statistical Press, 1987.
