Bank Credit, Changing Industrial Structures And Inflation-gap Persistence In China

Inflation persistence as a major macroeconomic variable, has been a source ofconcern for policymakers in China, due to its dynamic process’s principal role on themonetary policy analysis and strategy selection. Assessment of the current Chineseinflation persistence and its affecting factors will provide a theoretical basis for thecentral bank in monetary policy formulation and implementation on maintainingeconomic growth, adjusting economic structure and stabilizing inflation. Existedresearch to address the dynamic change impact of Chinese inflation persistence,mainly followed the paradigm of research in developed economies, which onlyconcerns with the total level but ignores the structural factors, and focuses oncommon factors but neglects the individual characteristics.In fact, structural changesand individual characteristics means that the basis of macro-control and the monetarypolicy transmission mechanism will change. In China, the bank credit channel is themain channel of the monetary policy transmission, total bank credit and it’s structuralchanges will have an impact on inflation.Even after cyclical bank credit factors isweakened, along with the growth drivers transfering betreew the inter-industriesduring the economic structural adjustment, the industrial structure adjustment mayalso make inflation persistence changeable. Therefore, it is necessary to analyze theimpact of bank credit and it’s term structures and the changingl industrial structurs onthe inflation persistence in China.Ralated researches on the assessment of inflation persistence mostly assumedlong-run equilibrium level of inflation as zero or constant, thus exlored the actualvalue of inflation as the substitution variable for measuring inflation persistence. Butin reality, the inflation target is not always static and can be changed from time to timeas policy evolves in response to changing circumstances and as policy makers learnfrom experience. In this case, if you do not take changing inflation targets intoaccount but directly use the actual inflationary value, it is likely to lead tooverestimation of inflation persistence and unnecessary cost of the policy. Thereby, the inflation gap persistence instead of inflation itself, defined as the differencebetween inflation and inflation target including trend target and policy target, areincorporated into the hybrid New Keynesian Phillips curve (HNKPC) model and useBlanchard-Quah structure decomposition to interpret the impact of industrial structureand bank loans and it’s term structure adjustment on inflation gap persistence in China.The conclusions are as following:Based on the policy target, trends target and fixed target respectively, threeinflation gaps persistence showed significantly different characteristics. Inflation gappersistence using the trend target and policy target are closer, but the fixed targetinflation gap persistence is higher than the two previous cases, indicating that the costof monetary policy under a fixed target will be higher. If the inflation target is higherthan the inflation itself, the inflation gap will be more persistent.To interpret these changes using a dynamic hybrid New Keynesian Phillips curvethat highlights the importance of structural changes in the money and real economy.From a monetary perspective, bank credit is the main channel of monetary policytransmission. In response to the three structural shocks including the demand shocks,supply shocks, as well as the total credit (term structure) skocks, both policy targetand trend target inflation gap are mainly affected by the demand shocks, more thansupply shocks. Compared to the policy target inflation gap, the total credit and itsterm structure placed less impact on the trend inflation gap persistence. Thecontribution of total bank credit shocks to the two inflation gap persistence is weak.The skocks of medium and long-term loan to the trend target inflation gap arestronger than the policy target inflation gap persistence, while skocks of short-termloan to the policy target inflation gap are more than the trend target inflation gappersistence. From a real economy perspective, as the most important part of china’seconomic structure, industrial structure adjustment induced changes in the inflationgap persistence. In the short run, the primary industry has positive impact on inflationgap persistence, while the secondary and tertiary industries have negative impact.Overall, the primary and secondary industries weakened the inflation gap persistence,while the tertiary industry strengthened it.The contributions of industry structurial shocks to inflation-gap persistence are the primary, tertiary and secondary industriesorderly. Therefore, controlling inflation must consider the influence of industrialstructure adjustment. From the comprehensive view of the monetary and the realeconomy, to increase output gap and bank credit will strengthen the policy target andtrend target inflation gap persistence, while to accelerate the primary industraldevelopment will weaken the two target inflation gap persistence.Both output gap andshort-term bank loan are important factors to affect the changes of inflation gappersistence. In the case of policy target, the contribution of the bank credit shocksmore than output gap, On the contrary, in the case of trends in target, output gap ismore significant.To conclution, the inflation gap itself has a certain persistence and the selectionof inflation target is crucial for a reasonable assessment of inflation persistence. Usingthe inflation gap rather than inflationthe itself to measure the inflation persistence willovercome overestimation the steady-state inflation persistence whose assumptions islong-run equilibrium level of inflation as zero or constant. Structural changes of themonetary and the real economy will affect the Chinese inflation persistence, and areasonable guide to inflation closer to its target must take full account of changes ofbank loan term structure and changes in industrial structure in order to avoid thepolicy overshoot. Policy makers shoud optimize the credit structure on the basis of themoderate total credit, increase the proportion of medium and long-term bank loans,and stabilize growth of the primary industry in the context of optimization ofindustrial structure to weaken the inflation gap persistence.