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Inflation Dynamics in China*1

July 2005
Ryota Kojima*2
Shinya Nakamura*3
Shinsuke Ohyama*4

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  • *1 We thank staff members of the Bank of Japan, particularly Kumiko Okazaki for constructive comments from the beginning. We are also grateful to Wataru Hirata, Ryo Kato, Takeshi Kimura, Shigeto Nagai, Yoshihito Saito, Wataru Takahashi, and Kenichiro Watanabe for helpful comments on an earlier draft. Any remaining errors are the authors' own. The views expressed in the paper are those of the authors and do not necessarily reflect the views of the Bank of Japan.
  • *2 Bank of Japan, Hong Kong Representative Office (formerly of the International Department),
    Email:ryouta.kojima@boj.or.jp
  • *3 Bank of Japan, International Department,
    Email: shinya.nakamura@boj.or.jp
  • *4 Corresponding author, Bank of Japan, International Department,
    Email: shinsuke.ooyama@boj.or.jp

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.