Study On Inflation Persistence In China

Inflation persistence is one of the important dynamic characters of inflation. The higher the inflation persistence is, the more lasting effects exogenous shocks will have on the real economy. Monetary authorities’counter-inflation policies will achieve the desired results much harder and the cost of reducing inflation will become more. So inflation persistence has specific policy implications.As Chinese economy integrates into international economy gradually since the21st century, dynamic characters of inflation become more and more complicated, and it brings serious challenge to the establishment and operation of our monetary policy whose primary goal is price stability. And the problem of whether inflation targeting is suitable for China becomes the focus of domestic scholars. So this paper is to research about Chinese inflation persistence and help central bank to establish and practice more efficient monetary policy, which is meaningful for the steady growth of our economy.This paper conducts empirical analysis based on theoretic analysis to study inflation persistence more systematically. Firstly, this paper tests whether there is any breakpoint in Chinese inflation series in the end of1994through exogenous structural change test. And then it uses AR model to measure reduced-form inflation persistence. This paper conducts a more scientific DSGE model from the new perspective of trend inflation to study the dynamic characters of inflation persistence. Lastly, based on new Keynesian model this paper analyses and compares the fluctuation of main targeting variables and welfare loss of central bank under commitment and discretion.The research results indicate that the breakpoint of Chinese inflation happened in the fourth quarter of1994. The reduced-form inflation persistence of China during1990to1994is high and it have declined since1995, but on the whole reduced-form persistence in China is relatively high. Among the exogenous shocks, trend inflation shock causes the permanent change of inflation and has the greatest impact on inflation. As to structural sources of inflation persistence, the paper points out that intrinsic persistence source is positively related to inflation persistence, while expected persistence source and exogenous persistence source are negatively related to inflation persistence. And the coefficients of lagged inflation and output gap have greater influence on inflation persistence.The research about new Keynesian analytical framework with lagged inflation indicates that output gap and inflation express high persistence after shocks under both commitment and discretion. And under commitment the fluctuation of inflation is greater. But after introducing trend inflation into NKPC, the fluctuation of inflation reduce a lot under commitment, which proves that commitment rule can reduce inflation persistence, however, the increase of output gap fluctuation leads to the increase of welfare loss. At the same time, fluctuations of inflation and welfare loss under discretion don’t have obvious change. So discretion is better than commitment from the perspective of welfare loss. As the proportion of output target in welfare equation of central bank increases, the fluctuation of output gap decreases, but the fluctuation of inflation and the welfare loss of central bank increase. So monetary authority should relatively reduce the weight of output target and increase that of inflation target in order to reduce inflation persistence and welfare loss.Our country should adopt flexible inflation targeting. That means conducting discretion rule under the restraint of committing an inflation target. In this way we can realize the long-time inflation target and consider other ecomomic targets such as output, so that we can reduce welfare loss to the maximum extent.