Essays On Inflation Dynamics And Monetary Policy In China

By the end-1990s, China’s economy has been characterized by high growth, high inflation, and high volatility. One of the most striking features since then has been a substential decline in economic volatility, especially for inflation dynamics as measured by its level and varibility. However, evidence from so-called autoregression with China data suggests that inflation may have been persistent over time.Inflation situation facing China is rather different from that of the OECD countries in recent years. China’s monetary authority is facing difficult chanllenges in response to various shocks, including supply shock as a result of a combination of the higher food, energy prices and labour costs, monetary shock due to liquidity surplus, demand shock coming from the large fiscal stimulus in response to the crisis in2008.The purpose of this essay is to address the above mentioned issues and to have a better understading of inflation process in China. The persistence of inflation, the dynamic response of monetary policy to different macroeconomic shocks are all features against which to assess the empirical and policy relevance of the New Keynesian Phillips curve (NKPC) model, in a way that is consistent with the goal of achieving price stablity.The study has opted for the NKPC model, monetary policy rule, and macro-finance model of thought approach as the theoretical base of this study. The hybrid NKPC model allows us to identify the relative roles of the forward-looking element and the backward-looking element as the driving factor in the inflation process, and sheds lights on disentangling intrinsic and inherited inflation persistence. Monetary policy rule depicts the possible combinations of inflation variability and output variability from which the monetary policymakers can choose in the long run, given the structure of the economy. Macro-finance model provides a profound understanding of the interlinkages between macroeconomic dynamics and the yield curves, the information content of the level and slope of the yield curve is highly related to the output and inflation.Highly persistent of inflation in China may well reflect the lack of credibility of the monetary authority’s commitment to price stability, the inertia in the formation of inflation expectation, and the price control. The empirical work on the NKPC shows clear evidence supporting output gap as a drving force for inflation process. Inflation dynamics seem well characterized by a Phillips curve in which both lead and lags of inflation are important. This result could reflect that fact rational expectation serves as the underlying microeconomic foundations for pricng decisions, and to some extent inflation appears to embody a sizable amount of intrinsic persistence. The weight of inflation is relative important in the preferences or objectives of the central bank, but the reaction of monetary policy to inflation has not been aggressive enough, and to some extent rather accommodative, leading to periodic "inflation scares". Macro-finance model shows evidences that the level of the yield curve provides valuable information about inflation expectation and serves as leading indicator for future inflation.Although substantial decline in the level and volatility of inflation occured in China, persistence of inflation are relatively high, the costs of disinflation is sizable in term of sacrifice ratio. These considerations raise several concerns, some of which will be addressed in this dissertation as follow. First, it proposes the use of persistent-weighted method to estimate China core inflation, for the sak of distinguish changes in the inflation trend from temporary movements around the trend. It presents the sum of autoregressive coefficient and the mean reversion as the indicators of persistence. The persistent-weighted core inflation shows better performance than that of other measures in following the trend inflation and predicting future inflation, and is highly correlated with monetary policy, thus useful for policy-making purpose. Second, it provides a case for inflation targeting as a monetary policy framework, with tangible bennifts of anchoring the inflation expectation, enhancing monetary policy credibility, while reducing inflation persistence.