Although there is hot debate among economic theorists over whether or not China is experiencing deflation, there is no doubt that price levels are continuously falling.

The latest statistics show that in July, the national consumers' price index (CPI) dipped by 0.9 percent compared with figures for same period last year, making it the ninth straight month of decline.

Theoretically, whether falling prices mean deflation or whether a country is experiencing deflation depends on whether the falling prices and contraction of demand are locked together.

From the latest data for the first half of this year, the growth rate of total sales volume of commodities slowed down as a result of weakening consumer demand and falling price levels. This has fueled a deflationary trend, causing declining demand and inducing falling prices, the article said.

Deflation is a monetary phenomenon that occurs when too little money chases too many goods. The insufficient money supply - the scarcity of money - leads to falling price levels.

But some economists insist that what triggered the downward spiral of prices was the slump in demand.

Some others believe that when there is glut in the market, the all-too-common response of producers is to engage in cutthroat price wars to maintain market share, which can ultimately lead to deflation.

It should be noted that deflation is always accompanied by falling prices but that falling prices are not necessarily caused by deflation, the article stressed.

Recent data show that, in fact, the government has not tightened the money supply in recent years. It has, on the contrary, cut interests rates eight consecutive times, but the prices continue to drop.

Then, what is the real factor behind the falling prices and deflation?

According to some economists, the problem is deeply rooted in the high-saving policy from the planned economy adopted by the country a long time ago. The policy suppressed the growth of personal income, which undermined people's purchasing power. Also, duplicated investment and construction led to immense overcapacity in production to further worsen the excessive imbalance between supply and demand.

Burdened by overcapacity, enterprises found it difficult to sustain business, and further investment enthusiasm was thus dampened.

The contraction of demand among both consumers and investors not only brought continuous price drops but also lead to weak currency demand for transactions. This finally lowered the currency in circulation or its circulation speed, which gave rise to deflation.

The difficulties of enterprises and low economic growth in turn had a negative impact on personal income growth and dimmed their future expectations, which forced them to tighten their purse strings. Such weaker demand then pushed prices even lower.

Thus, the gap between demand and oversupply continues to expand, price levels keep falling, and a vicious cycle of deflation has taken shape. Thus, deflation will be a challenge to China's economy for quite a long time. The government should adopt farsighted macroeconomic policies to effectively solve the issue, the article urges.

Up till now, the common antidote to deflation preferred by the government is to focus on stimulating overall demand. A proactive fiscal policy and stimulative monetary policy have been adopted.

However, the stimulus packages have not brought the desired results because the policies that aim to spur investment demand have failed to revive consumer demand, according to the article.

At present, economic growth is largely sustained by government spending programmes. But any easing of the current fiscal policy will exacerbate the deflationary trend.

The right solution lies in rational adjustment of the ratio between saving and consumption to promote sustained economic growth. In order to do this, relevant distribution, investment and pricing policies will require appropriate reforms, the article concluded.

(China Daily August 30, 2002)