China's Inflation and Political Cycles

Examining all inflationary cycles during the reform era (1978-present), this paper finds out that China's inflationary cycles during the reform era exhibit a clear pattern that the increase of the growth rate of money supply directly results in inflation expectation, and the decrease of the growth rate of money supply quickly suppress inflation. With a dominant presence in financial system, the Chinese Communist Party (CCP) can intervene in monetary policy at any time while People's Bank of China (PBOC, China's central bank) lacks independency. Thus, the primary driving force of the volatility in money supply is the choice of policy direction between “Stability” and “Development”, which has close relationship with political cycles represented by the change of CCP's General Secretary.The top Chinese leaders face threats to their power due to the deficiency of an institutional succession mechanism. The first priority of a new General Secretary is his power consolidation and social stability rather than economic growth. With the consolidated power (usually 2-3 years after the inauguration), the new leader will galvanize political enthusiasm for economic development by carrying out loose monetary policies, which set off rapid monetary expansion and then ultimately inflation. When inflation rises above a certain threshold, it will lead to social discontent and shake the leader's power and the Party's ruling foundation. Under political pressures from all around, it will become consensus of the central leadership to suppress inflation and tighten the monetary policy. Due to the strong institutional capacity of CCP, inflation will be suppressed quickly. It can be observed that the fluctuation of China's inflation may be high yet the duration of China's inflation period is short, which demonstrates a significant inversed “V” curve. Of course, in different inflationary cycles, the degree of social tolerance and the political power balanced within leadership groups is varying, which cause pace and intensity of tight policies varying as well. Thus the peak and duration of different inflationary cycles vary accordingly