The strength of the inflation-output link in China
Summary
Focus
We study how inflation in China relates to the state of the economy and to people's inflation expectations. We use the Phillips curve, a standard model that links inflation to these factors, and work with recent quarterly data and survey forecasts from Consensus Economics. We test both closed economy and open economy versions of the model, which adds external drivers such as exchange rates. We check how stable the results are across different samples and model choices.
Contribution
China plays a major role in global trade and supply chains. A clear link between inflation, slack and expectations would help policymakers and markets read the business cycle and judge policy trade-offs. Earlier studies for China found weak or mixed results, often due to older data, rapid structural change and a lack of direct measures of expectations. We address each of these gaps and also bring in external factors, reflecting China's openness. Our approach explores whether a widely used policy framework applies to China without special adjustments.
Findings
We find a strong and stable link between inflation, slack and expectations in China. Inflation is also slow to adjust, with past inflation as equally important a factor as expectations. Open economy versions fit the data better than closed economy ones, but the difference is not large. The results also hold up if we use other measures for inflation and slack, or different ways of expressing the Phillips curve model. Our results imply that the Phillips curve model can be used to understand China's inflation. Helping people form accurate views about price changes and the state of the economy matters for keeping inflation low and steady.
Abstract
We systematically investigate the relationship between China's inflation, economic slack, and expectations through the lens of New Keynesian Phillips Curves (NKPC). Extending existing research, we employ inflation expectations from Consensus Economics over recent samples and assess the stability of the estimates. Despite China's unique and evolving institutions, NKPC estimates are stable and show significant roles for both the output gap and inflation expectations in contrast to previous findings. Incorporating open-economy variables marginally enhances the models performance. Our results suggest that the New Keynesian framework can be adopted to China without adjustments for specific institutional features.
JEL classification: E31, E37, E58
Keywords: China, inflation, New Keynesian Phillips Curve, emerging markets