Guoqing Song: Prices of Agricultural Products and Inflation

 date:2008-8-20 9:45:00          

Prices of Agricultural Products and Inflation

Guoqing SONG

Professor, CCER at Peking University

In China, the growth rate of food price is higher than the average during inflation and lower than the average during deflation. To explain this phenomenon, there are two hypotheses. The first one is that food price pushes inflation, and that food price is determined by international market and domestic weather.

The author provides an opposite explanation: oversupplied money causes inflation, and food price are pushed by inflation. If nominal interest rates are not adjusted as fast as inflation rates during economics expansion, real interest rates will be too low. Low interest rate will result in investment boost in non-agricultural industries, which will absorb more labor and make labor input in agriculture decrease relatively. As along with the exhaustion of agricultural inventories, real agricultural prices will increase.

Current situation in the real estate market is similar to what happened in late 1980s. Prices grew fast in 1988 but sale in physical amount decreased because of high inflation expectation. In the next year the severest recession occurred. Such experience tells us that it is extremely harmful to hesitate on inflation and let inflation expectation form.

Undervalued RMB exchange rate is so harmful to the economy that it is even worthwhile to compensate those who might be hurt by RMB appreciation in order to get their support for RMB appreciation. The compensation is not necessary in theory but may be the second-best choice in practice. A suggested policy is to provide three years' value-added tax exemption to export-oriented firms.

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