A SAVINGS account which offers non-negative interest rates should be introduced as one way to fight inflation while not hurting the economy, Morgan Stanley suggested in a recent report.
"We explore an alternative anti-inflation approach - the Government-financed Inflation-proof Deposits scheme, under which the government subsidizes households to ensure non-negative real interest rates on certain types of their saving deposits with the objective of enhancing the policy-makers' anti-inflation credibility," said the US investment bank.
The GID scheme should be a powerful policy tool in managing inflation expectations. The scheme is not new to China which dropped it in 1996 due to low inflation then.
China's consumer price index, the main gauge of inflation, has been rising rapidly since the middle of last year. It reached a nearly 12-year high of 8.7 percent in February.
To tame inflation, China has raised interest rates six times and reserve requirement more frequently since last year.
Wang Qing, a Morgan Stanley economist, thinks that although price controls can help stabilize inflation expectations in the short run, they are not sustainable.
"To impose price controls is essentially to ask owners of companies affected (or investors) to pay for the anti-inflation cost in the form of squeezed profit margins. This is not sustainable, as it is fundamentally against investors' commercial interests," said Wang.
Government subsidies to the low-income population, on the other hand, help ease the negative impact of inflation on their life, but they do not help control inflation expectations.
"The critical issue is that before the supply-boosting effect (thanks to government subsidies to farmers) and demand-reducing effect (due to slower exports amid a US-led slowdown in external demand) kick in, how will the policy makers manage to prevent inflation expectation from running out of control. We suggest the scheme for this purpose, the government should spend money but in the right way," Wang said.
To fears the GID plan could be costly, Wang believes the government needs to compensate for long maturity deposits of above three years.