Study On China's Core Inflation

Presently, more and more countries and regions have built their core inflation indices and consider them as an important concern of monetary policy. China's National Bureau of Statistics and the People's Bank of China have begun to pay attention to core inflation when analyzing inflation tendency and formulating monetary policy, but core inflation index is still not calculated and published periodically. In this context, this paper makes a systematic study of core inflation in China. Study on China's core inflation have practical and theoretical significance on accurately judging the long-run and underlying trend of China's inflation and scientifically making monetary policy. The research work and research conclusion of this paper can be summarized as follows.This paper first analyzes the connotation of core inflation and methodologies to measure it. By synthesizing the classic paper on core inflation of Eckstein (1981), Bryan, Cecchetti (1994), Quah, Vahey (1995), Romer (1996), Blinder (1997), Roger (1998), Bagliano, Morana (2003a, 2003b), Cristadoro et al. (2005), the paper defines core inflation as the permanent common component of CPI which reflects the potential long-term tendency of inflation and can act as a focus of monetary policy by deducting the transitory component from sub-indices of CPI. Current methodologies to measure core inflation are mainly statistical or based on econometric models. Since there is no clear cut between core inflation rate and common inflation rates, measuring core inflation rate accurately is of great difficulty. At present, there is no single method can satisfy all the following qualities, that is, computable in real time, forward looking, understandable by the public, having sound theoretical basis and history does not change.On the basis of above research, the paper analyzes the deficiencies of China's price index system in force. Although the current price index system composed of representative indices such as consumer price index (CPI), retail price index (RPI) and producer price index (PPI) can reflect the inflation level with approximate accuracy, there still exist deficiencies such as inability to precisely reflect the purchasing power of consumers, inaccuracy and incomparability of price indices, easily affected by short-term volatilities thus misleading monetary policy. Consequently, it is necessary to index core inflation so as to perfect the present price index system.By applying the method of orthogonal decomposition of adjustment coefficient matrix in cointegation-VECM models proposed by Gonzalo and Granger (1995), this paper measures the core inflation rate of China through solving common factor of the cointegration system. The result shows that, in the sample period from January 2001 to January 2009, the mean and standard deviation of China's core inflation are smaller than those of CPI. Moreover, the wave crests and troughs and the frequencies of fluctuations of core inflation are basically the same as those of CPI, which indicates that the core inflation of China reduces the volatilities of CPI and reflects the potential long-term trend of inflation.Fatherly, the paper addresses the structural characteristics of China's inflation. The reason why core inflation index is paid so much attention to is that the fluctuations of sub-indices of such comprehensive price indices as CPI and PPI are structural. Based on the analysis of the descriptive statistics of the fluctuations of sub-indices of CPI and PPI and by applying methodologies proposed by Gonzalo and Granger (1995) and by Darrat and Zhong (2002) respectively to test permanent driving force and transitory driving force in cointegrated systems, the author reached the conclusion that there are obvious structural characteristics in China's inflation. Since the fluctuations of food prices are not only the transitory driving force but the permanent driving force of CPI fluctuations, it is unscientific to exclude food prices when measuring core inflation in China.Finally, the paper analyzed the pros and cons of the monetary authorities to focus on core inflation. To focus on core inflation is not only advantageous for central bank to predict the trend of inflation more precisely, but also helpful to reduce the variabilities of monetary policy and maintain the reliability and credibility of monetary policy. But there are also policy risks if monetary policy is too much affected by core inflation. Because fluctuations of food prices and energy prices may contain useful information about future inflation, the ignorance of them may lead to inaccurate prediction of the trend of future prices thus disadvantageous for effective control of inflation. Consequently, When China adjust monetary policy according to the transitory fluctuations of prices, the headline inflation index such as CPI should be mainly concerned, and the core inflation index should be pay attention to in the same time in a forward-looking way. According to the author's measurement, the core inflation inertia of China is 0.883. The bigger the inflation inertia, the larger the lagged effects of monetary policy on prices and the monetary authorities should pay more attention to core inflation in a forward-looking way.Based on the above research work and research conclusion, the main innovations of this paper are as follows: (1) In the terms of research viewpoint, this paper firstly study the connotation of core inflation and methodologies to measure it and its meaning of monetary policy in China's academic circles. (2) In the terms of methodology, this paper firstly apply the method of orthogonal decomposition of adjustment coefficient matrix in cointegation-VECM models proposed by Gonzalo and Granger (1995) and methodologies proposed by Gonzalo and Granger (1995) and by Darrat and Zhong (2002) respectively in China's academic circles. (3) In the terms of application, this paper firstly analyze the structural characteristics of China's inflation and measure China's core inflation in accordance with China's CPI(PPI)basket composed by eight(seven) sub-items. According to the China's core inflation rate measured by author, this paper firstly applies the ARIMA model to fit the dynamic adjustment behavior of China's core inflation and measure its inertia characteristics.