Inflation Dynamics in China

Abstract

This paper comprehensively investigates inflation dynamics in China. First, we estimate a structural vector autoregression to verify the 'consensus view' of inflation dynamics in China. We provide the results of basic empirical analyses on inflation mechanisms in China. In the context of the relationship between the output gap and the conventional Phillips curve, we find that the output gap proxied by electricity consumption per unit of capital is a better measure of inflation pressure than another alternative. Based on our analysis of the relationship between input and output prices, we show that wage growth is a substantial determinant of inflation. The estimation of the long-run equilibrium relationship between money, output and prices clearly indicates that the money gap (i.e., the gap between the actual and long-run equilibrium levels of money) Granger-causes consumer price inflation. Based on these empirical results, we assess current inflation and the outlook for inflation in China and draw policy implications.

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