Inflation Dynamics In China: Based On Micro-foundations

Since this century, China’s economy has been developed rapidly, and becomingthe world’s second-largest economy. Accompanied by the great increase in the GDP,the inflation problem in China is getting much more attention by economists. In orderto prevent a global economic crisis influence on China, after the subprime crisis in theUSA, Chinese government has implemented a proactive fiscal policy and amoderately loose monetary policy. Positive macroeconomic regulation and controlavoid the huge fluctuations of China’s overall economy, but the cost of it is theinflation problem. European debt crisis has a great impact on China’s foreign tradeindustry, the domestic commodity prices decline, to some extent reduced the externalinflation pressure in China. But if the European government take an accommodatingmonetary policy in response to the crisis, that will promote inflation rate in Europeand even China. In the ever-changing global economy, economists paid moreattention to the inflation dynamics research.First of all, give a literature review of the inflation dynamics, from theoreticalresearch to empirical research, from the traditional inflation dynamic model to theinflation dynamics model based on the microeconomic foundation, macroeconomicand microeconomic theory have a very good integration. The most popular research isbased on micro-foundations to study the inflation dynamics. Unfortunately, there isvery little empirical literature based on dual sticky inflation dynamic model to studythe Chinese inflation dynamics.Secondly, give the theoretical model of NKPC (New Keynes Phillips Curvebased on sticky price), SIPC (Sticky Information Phillips Curve) and DSPC (DualSticky Phillips Curve). On the basis of the theoretical model, the third part of this paper gives aempirical analysis of inflation dynamics based on NKPC, SIPC and DSPC, using thequarterly data of China from1996to2012. Before the empirical research, theinflation rate data, the output gap data and the data of actual marginal cost isdescribed and seasonally adjusted, excluding the impact of seasonal factors. Byconstructing a VAR model first and then using the instrumental variable projectionmethod to get the expected sequence of inflation and actual marginal cost data.Finally, use the TSLS (Two Stage Least Squares) method to estimate the parametersof the three models. The estimate results show the inflation dynamics in China isdifference between the NKPC, SIPC and DSPC model.The estimate results of NKPC based on sticky price show that each quarter,about66%of the companies choose not to reset the product prices, that is to say, theaverage period of the enterprises reset their prices is about nine months or so. Theestimate results of SIPC based on sticky information show that each quarter, about50.8%of the companies choose to update the information, that is to say, the averageperiod of the enterprises update their information is about six months or so. Theestimate results of DSPC based on sticky price and sticky information show that eachquarter, about63.4%of the companies choose to maintain the product prices, that isto say, the average period of the enterprises reset their prices is about eight months orso; each quarter, about68.6%of the companies choose to update the information, thatis to say, the average period of the enterprises update their information is about tenmonths or so. By contrasting the inflation dynamic model NKPC, SIPC and DSPCbased on micro-foundations, it shows that both sticky price and sticky informationfactors are significant. So the DSPC inflation dynamic model is more suitable forChinese data.In the fourth part of the paper, analyzed the impulse response of inflation to themonetary policy shocks, and built a monetary policy analysis framework based on dual sticky inflation dynamic, which provides a direction of the future analysis ofChina’s monetary policy.One of the improvement directions of this paper is introduce the globalizationfactors to the dual sticky inflation dynamics, and construct a dual sticky inflationdynamic model under open economy based on microeconomic foundations. Thesecond direction needs further study is integrate the dual sticky inflation dynamicmodel, the New Keynes aggregate demand model with monetary policy, and based onthis framework to study the optimal monetary policy in China. In this paper, onlygives the framework of the study, but didn’t analysis the optimal monetary policyunder different rules of monetary policy. So we can go on analysis of this direction inthe future.