What Causes China's High Inflation? A Threshold Structural Vector Autoregression Analysis

Fang Guo

China & World Economy, 2013, vol. 21, issue 6, 100-120

Abstract: China's astonishing economic growth implies a necessity to understand its inflation. The present paper employs threshold nonrecursive structural vector autoregression analysis to explore the asymmetric effects of macro-variables on inflation in low and high inflation regimes. The empirical evidence demonstrates, first, that the reactions of inflation to various shocks are inflation-regime-dependent and asymmetric. Second, monetary policy influences China's high inflation and adjusting the domestic interest rate in China may be an effective way to control inflation in a high inflation regime, but not in a low inflation regime. In a high inflation regime, a high inflation rate may cause the macro-policy authorities to increase the domestic interest rate, in an attempt to stabilize high inflation. Third, contrary to expectations, the world oil price is not a strong cost-push factor in a low inflation regime. Oil price increases may increase inflation in a high inflation regime, but there is no such obvious effect in a low inflation regime. Finally, China's nominal effective exchange rate influences inflation in both low and high inflation regimes. A nominal effective exchange rate appreciation might be effective in controlling domestic inflation in both regimes.

Date: 2013
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