A Study On The Differences Of Welfare Costs Between Urban And Rural Inflation

In the early1960s, the welfare cost of inflation has gradually attracted the general attention of the international researchers. Economists generally agree that higher inflation will hinder the market price mechanism to optimize the allocation of resources to play this basic function, so that social and economic development deviate from Pareto optimal state, resulting in net loss of social welfare. Since the reform and opening up, China has experienced high inflation in the late eighties and mid-nineties, but also to maintain price stability in the decade after1996, until2007began a new round of non-equilibrium structural inflation. Because of the special circumstances of urban-rural dual economic structure, rural residents and urban residents have to face substantially different price levels and inflation costs. Since2001the rural CPI has been higher than the city CPI and inflation trends in the rural area at high speed does not change. As the result, the welfare cost of inflation will eventually bring greater pressure on rural residents.Therefore, the government needs reasonable control of the price level in the current complex economic situation. Moderate inflation can reduce unemployment and stimulate economic growth while the high inflation will result in an invalid configuration of social resources. This paper attempts to quantify the welfare cost of inflation, to help the government to find a reasonable price level. Make effort to reduce the impact of the gap between urban and rural living standards, take into account social equity and minimize the welfare losses at the same time.Based on the remaining triangles of Baily model, the paper firstly use the indicators of narrow money supply, bank lending rates and GDP during1992-2012to build the long-term money demand function structure, and calculate the welfare cost of inflation in China. After calculation we can find that the actual welfare losses is not as much as imagined. Even in the1994inflation rate was higher than24%, the welfare cost of inflation reached62billion only. That is to say, the level of inflation and GNP together determine the welfare costs. Meanwhile, in the deflationary period around1998, the welfare loss also did not disappear, which not only verifies the negative effects of deflation on the economy, but also that the level of inflation is just one of the factors affecting the welfare costs.Combined with the features of urban-rural dual economic structure this paper improved the long-term urban and rural demand function on the basis of the original model, making the use of the benchmark lending rate and deposit rate index. From the simplified model, we could find out that either during the inflation or deflation period, either higher or lower than the urban rural CPI, the rural residents bear the higher costs of welfare than urban residents, the biggest gap has even reached950million. We can see that although the welfare losses reacted to inflation with a certain lag, the fluctuation of both had great consistency, which have shown that the difference of the welfare cost of inflation between the urban and rural residents is not just determined by the level of inflation. It is also affected by many other factors.In essence, the root cause of this difference lies in the urban-rural dual structure and the level of the market economy, as demonstrated by the level of inflation in different urban and rural areas, the policy of financial repression excludes the natural fluctuations in interest rates which should be a free market indicator based on supply and demand of market funds. The allocation of resources does not fully play the basic role. In the meantime, some models’assumes have not been met in our country, such as a stable currency adjusted growth rates and the role of adaptive expectations. Besides, the structure of assets held by residents, consumption structure, income levels and other factors all have an impact on the welfare cost difference of urban and rural residents.Finally, this paper proposed some policy recommendations based on the analysis of the results which provides valuable reference to the cost allocation problem arising in the course of dealing with inflation.