The New Challenges of Inflation and External Imbalances Facing China^*

China is facing the threat of inflation, at the same time that the U.S. economy is in trouble. To maintain a sustainable growth rate, China must walk a tightrope. On one hand, China must tighten its monetary policy to bring inflation under control, which will slow down the growth rate of the Chinese economy. On the other hand, China also has to be ready to use expansionary fiscal policy to replace the weakened external demand to prevent its economy from falling into a “growth recession,” where the growth rate is below 8 percent, due to the double whammies of monetary tightening and a significant slowdown of the U.S. economy.