Modelling inflation in China – a regional perspective

In this document, we model provincial inflation in China in the reform period. Particularly, we’re excited about the potential of the hybrid New Keynesian Phillips Curve (NKPC) to capture the inflation process at the provincial level. The research illustrates variations in inflation formation and demonstrates that the NKPC offers a fair description of the inflation process limited to the coastal provinces. A probit analysis demonstrates that the forward-looking inflation component and the output gap are crucial inflation drivers in provinces which have advanced most in marketisation of the economy and have probably encountered excessive demand pressures. These results have significance for the relative usefulness of monetary policy in the Chinese provinces.

China’s fast growth and ever-increasing economic significance indicate a requirement to understand its inflation developments. While some reports have documented the potential of the New Key-nesian Phillips Curve (NKPC) to capture the inflation process in the Mainland, much less attention has been given to differences across China’s provinces. This is significant, as aggregate numbers hide substantial variations in economic performance and different degrees of market development across regions, and institutional differences between provinces may influence the link between output growth and inflation.

Source: Institute for Economies in Transition, Bank of Finland

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