Global Economy
Inflation from Asia? Not Likely

Jahyeong Koo and Dong Fu examine current inflation conditions in China, Korea and Japan and the possible effects on U.S. inflation.

Inflation is surfacing in China and Korea. In particular, China’s economic expansion is putting upward pressure on global raw material prices. We briefly examine current inflation conditions in three major East Asian economies and the possible impact of increases in raw material prices on U.S. inflation.

Inflation in Asia Is Moderate, If There Is Any
With real GDP growth of 9.7 percent in first quarter 2004 and continued fast expansion since, China’s year-over-year CPI inflation rate rose to 3.8 percent in April, the highest in seven years (Chart 1). The People’s Bank of China’s lax monetary policy until very recently had contributed to a rapid credit expansion. In addition, shortages in energy and raw materials pushed up prices. To cool the economy, the People’s Bank of China has raised the official reserve ratio three times since last August and is likely to hike interest rates soon.

Chart 1

Korea’s year-over-year CPI inflation rate has been stable over the past year, reaching 3.1 percent in March. Yet the month-over-month CPI inflation rate was an annualized 6.6 percent in March, a result of international price increases in raw materials. In addition, PPI inflation has increased sharply recently, suggesting that further price increases at the consumer end may already be in the pipeline.

In Japan, there is anecdotal information that companies have raised the prices of some goods and services, such as lithium batteries, steel and air cargo—reflecting the run-up in raw material costs. The recent increases bolster hopes that years of deflation may finally be over. However, the price increases have yet to show up in the CPI. Improving domestic demand and business sentiment should eventually exert upward pressure on prices. Until then, the Bank of Japan seems determined to pump liquidity into the system.

High Raw Material Prices Have Limited Impact on U.S. Inflation
China’s extraordinary growth has pushed up raw material prices. The impact has spread far beyond its borders (Chart 2).

Chart 2

In the first four months of this year, China’s crude steel production was up 24.5 percent from the same period last year and accounted for 24.7 percent of global output (Chart 3). Moreover, China also consumes 37.5 percent of the world’s cement production. Its energy consumption is about 10 percent of the world total and is increasing at an annual rate of 11 percent.

Chart 3

Rising commodity prices have, in some cases, forced Asian and U.S. manufacturers to pass these higher costs on to consumers. But the limited share of raw material in the total cost of manufactured goods means the impact on overall world inflation has been limited. Especially in the case of the United States, Asia-inspired price increases should be limited in size and duration. First, the United States does not depend on international trade as much as other developed nations; imports account for only 14 percent of U.S. GDP. Second, commodity prices rose after previous recessions without noticeable impact on U.S. inflation at the consumer level, as Federal Reserve Governor Ben Bernanke recently pointed out.[1] Furthermore, raw material price increases are generally one-time shocks, which may push up the price level at the moment but will not have lasting effect on the inflation rate per se. In the end, U.S inflation depends more on the domestic economic expansion, including job creation.

Conclusion
Inflationary pressures in China and Korea are building, and anecdotes suggest Japanese manufacturers are starting to raise prices. So far, however, the price is very much under control in these countries. It is unlikely that high raw material prices due to Asia’s growth will cause significant inflationary pressures in the United States. The possibility that Asia-inspired inflation will pick up noticeably outside Asia is also quite low.

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