Deflation in China: Why Prices Are Falling and What Beijing Can Do

July’s data left no doubt: China is now clearly dealing with a deflation threat. Consumer and producer prices fell together for the first time since 2020, adding to concerns about the health of the world’s second-largest economy. News that China’s prices are falling may be somewhat jarring, given the inflationary pressures in many other parts of the world. But the unique factors contributing to China’s problems are deep and ingrained. Solving them may not be an easy fix.

Inflation rocketed higher in the US and other major economies as they reopened after the Covid-19 pandemic, with pent-up demand fed at times by government handouts. At the start of this year some economists predicted the same would happen in China, which ended its Covid curbs later. But that hasn’t been the case. Consumer spending growth remains subdued, while a prolonged property slump has dented confidence, holding people back from buying big-ticket items and impacting prices for furniture and home appliances. Energy prices have been falling, too, given weakness in global commodity costs and Beijing’s long-standing control over the power sector. A price war among carmakers has added to deflationary pressures, while companies are also cutting prices to reduce the excess stock they built up over the pandemic. Prices aren’t falling across the board, however. Spending on services, such as travel and restaurants, has surged since pandemic restrictions ended, with prices continuing to rise in those sectors.