"Inflation is always and anywhere a monetary phenomenon." – Milton Friedman, 1976 Nobel laureate in economics.

China's consumer price index in November registered 5.1 percent, reflecting the rapid growth in recent years. Large inward foreign direct investment and portfolio investment, plus the continuing large current account surpluses, have constituted a demand for Chinese currency. The upward pressure on the exchange value of the renminbi against the US dollar goes hand-in-hand with the one-way bet for the expectations of renminbi appreciation, which in turn further causes investors' speculative financial inflow into China.

To maintain exchange rate stability, China's monetary authority has to tackle foreign exchange market forces by increasing its holdings of foreign exchange reserves, mostly in dollar-denominated assets, which increases the money supply and liquidity in the economy. Monetary growth from such a channel has become rather significant, despite China's monetary authority's sterilization effort, such as increasing the mandatory deposit reserve amount and outright sales of the central bank's renminbi-denominated bills through auction and a "targeted issue" scheme to banks. The resulting money expansion chases both commodities and assets, pushing up the prices of goods and services as well as asset prices in the markets for housing and equities. Although asset prices are not directly part of inflation statistics, they indirectly influence people's consumption and investment expenditures through the "wealth effect": the higher the asset prices, the more wealthy people feel about themselves, and therefore the more they are willing to spend on goods and services.

Should China, a fast-growing and the largest emerging economy, take inflation as a red flag and seriously deal with it? The answer is yes, according to the monetary theory and China's past experience. In particular, checking high inflation is the major statutory mandate to any central bank in the world. Even if we take into account China's developing country status and that having to keep rapid economic growth for overall development, it does not deny the necessity and importance of inflation control in promoting a sustainable and balanced economic growth. Indeed, China's thresholds for inflation target and the natural rate of output growth are higher than those in developed countries, so there should be more room for acceptable inflation and economic growth. Nevertheless, the resulting economic and social cost of inflation in a developing country like China has turned out to be higher than that in developed countries because of some underdeveloped aspects of social infrastructures that are not compatible with the dramatic adverse impact on income redistribution caused by high inflation.

Undoubtedly, checking inflation is not cost-free since it will inevitably affect the established interests and economic order to a certain extent. But letting inflation get out of control could be even more costly to the economy. The question is how to check the inflation. It is certainly important for China's monetary authority to show its commitment, determination and firmness in fighting inflation, as inflation may not be easily controlled. Hence, the monetary authority's credibility in maintaining price stability is critically important, which is also why it is widely accepted in today's economics literature that the central bank should keep its independence in monetary policy decision making.

An equally important thing is that fighting inflation should minimize possible associated economic and social costs as well. Fighting inflation is like an art as well as a science. A successful campaign against inflation should be the one that can achieve its goal with minimal cost. A soft landing for inflation depends critically on how inflation expectation can be managed and stabilized. Given that inflation is a monetary phenomenon, necessary monetary policy moves have to be firm and credible. To have the best policy effect, monetary policy can be used together with other policy measures, such as sequenced and gradual currency appreciations, fiscal measures that aim at income structures, as well as subordinated legal and administrative measures.

The author is a professor of Economics of Salisbury University, United States.

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