We explain the causes of inflation in China starting at the second half of 2007. Due to series of policy distortions which lead disproportional allocation of resources between manufacture and service sector，China has been accumulating huge trade surplus since 2004. Trade surplus bring about expectation of RMB revaluation and hot money inflow and left monetary authority with series of challenges，such as base money growth，changing money multiplier and unstable relationship between money intermediate targets and inflation.