China’s economy expanded 10.7 percent in 2006, its fastest rate of growth in eleven years, due to strong exports and investment spending. The pace was somewhat faster than most observers had anticipated and occurred despite Chinese attempts to cool the economy through selective credit controls. Chinese planners apparently view the current rate of economic growth as too fast and destined to run up against capacity constraints—notable in electricity generation. Economists anticipate slower growth this year, around 9-1/2 percent, but a year ago, economists issued the same prediction for 2006.
Despite the rapid economic growth and concerns about building price pressures, inflation in China has remained fairly subdued. Last year, consumer prices advanced only about 1.6 percent on average.
One thing that might help limit inflationary pressures in China is allowing the renminbi to appreciate faster against the dollar. Under its peg and subsequent limited float, China has accumulated a huge portfolio of foreign exchange, mostly dollars. All else constant, China’s monetary base should keep pace with its reserve accumulation, but the Peoples Bank of China has offset (sterilized) roughly one-half of the impact since early 2001 by selling bonds to the market. This cannot continue indefinitely. Greater exchange rate flexibility would help limit China’s reserve accumulation.