The Extension And Empirical Test Of New Keynesian Phillips Curve In China

The New Keynesian Phillips Curve (NKPC) is currently the most widely acceptedtheory of inflation dynamics in modern macroeconomics. The construction of China'seconomic performance characteristics of the New Keynesian Phillips curve model will helpto discard the traditional inflation theory and build a general analytical framework tounderstand the formation mechanism of inflation in China.In the assumption of rational expectations and the economic structure, the classic NewKeynesian Phillips curve has established two departments of the economy which includefamily and manufacturers. In this model, manufacturers make optimal pricing decisionsunder rational expectations and the household consumption is exactly equal to the output ofmanufacturers when in the equilibrium which means rational expectations and consumerdemand are the key factors of inflation. Therefore, building New Keynesian Phillips Curvein China which contains the characteristics of economic structure and inflation expectationsin China would help to explain China's inflation.In the study of inflation expectations, according to the characteristics of the Chinesepublic survey data, we improved Carlson-Parkin's probability method, and quantified theinflation expectations qualitative survey data. Compared to the traditional Carlson-Parkin'sprobability method, this method has the smaller error between the inflation expectation andactual inflation. Through adaptive expectations test and rational expectations test such asbias, validity and orthogonality tests, results show that the inflation expectation of ourpublic is irrational expectations and possess a certain degree of rationality. Under irrationalexpectations, inflation persistence will have an impact on inflation. Therefore, we examinethe characteristics of China's inflation persistence by Largest Autoregressive Root (LAR),Cumulative Impulse Response Function (CIRF) and Half-Life (HL) tests. The resultsindicate that during the first quarter of1990to fourth quarter of2010, China's inflationpersistence is at a high level and shows inverted u-shaped trends. Endogenous mutation teston inflation persistence finds that inflation persistence occurred structural break in the firstquarter of1998. In terms of characteristics of China's economic structure, unlike developed countries,China's economic growth was mainly driven by investment. Local governments andstate-owned enterprises have the impulse to invest, thus the sensitivity of the investmentcost is very low, which means investment has a strong pull for inflation.Based on the above characteristics analysis, we divide demand into investment andconsumption from the microscopic point of view, and then combined the sticky expectationand sticky prices to form a double-stick model of New Keynesian Phillips Curve in China.This model based on classical theoretical models includes inflation persistence andinvestment. The model implies that the effect of investment on inflation will be higher thanthe consumption under the assumption that the price elasticity of demand for investment isless than consumption. The model also means that inflation persistence is an importantfactor affecting China's inflation, and the impact of inflation persistence on inflation will behigher as manufacturers less prefer forward price-making.The empirical results show that the New Keynesian Phillips Curve in China, takinginto account inflation persistence and the economic structure model, can explain China'sinflation formation mechanism better than classical model. Inflation persistence significantimpacts inflation, after inflation expectations. As the monetary policy regime changed, theimpact of inflation persistence to inflation dropped significantly. The results also confirmthat the impulse of investment by local governments and state-owned enterprises has astrong effect on inflation.The conclusions indicate how to resolve the problem of inflation in China. First,through the reform of promotion system in local government and deepening reform thestate-owned enterprise, we could crack the soft constraint problems of investment so as toreduce inflation pressure from the internal economic structure. Second, we should perfectmonetary policy system in order to reasonable guide inflation expectations and reduceinflation persistence level which would alleviate the internal pressure of inflation.