The Causes Of The Recent Inflation In China

2003witnessed the beginning of a new stage of China’s economic development. Since2003, we have experienced three periods of inflation as well as the continuous rapid growth China’s economy. What havegone along with the inflation are rapid growth in money supply, surging demand, hike in wages and prices of primary commodities. In order to analyze the causes of recent inflation in China, we build anextended version of new Keynesian Phillips Curve by adding monetary shocks to Ghali’s expectation augmented model. According to New PoliticalMacroeconomics, the economic and financial institutions play an important role in the process of inflation. Based on the view above and our model, we come up with a framework to analyze the causes of inflation. Theoretically, monetary shocks, aggregate demand pressure, cost shocks, inflation expectations, economic institutions are the main causes.In order to understand recent inflation dynamics, we make econometric estimations using VAR approach based on the framework. After analyzing the impulse responses and variance decomposition, we find that the inertia in recent inflation is obvious. Demand pressure is the most important cause of recent inflation. Excess wages and hike in primary commodity prices account for a smaller proportion of recent inflation. However, if they are taken as a whole to represent cost shocks, we can draw the conclusion that aside from demand pressure cost shocks contribute quite a lot in causing inflation. Surprisingly, monetary shocks are the least important causes. The result is contrary to the idea that inflation is always a monetary phenomenon.The empirical results are closely related with the situation of our economy. Due to the endogeneity of money supply and the development of capital market, the recent inflation should not be attributed to rapid growth of money supply. Secondly, the economic growth is driven by fixed investment and export since2003, which lead to great pressure in aggregate demand. Strong aggregate demand is the most important original cause. Thirdly, with the reform in factorinputs market and the opening up of our economy, the undervaluation of most factorinputs are justified, the hike of factorinputs’ prices, such as wages and primary commodities, leads to cost shocks, which is the less important original cause. Although inflation expectation is not original cause, it’s extremely important in the process of inflation due to its interaction with other original causes. By analyzing the causes we find that economic and financial institutions breed the inflations causes mentioned above. In order to control inflation effectively, reformation of economic and financial institutions is needed other than proper financial and monetary policies.