Estimation Of Chinese Phillips Curve Based On Quantile Regression

The variations in output and price level are two important issues on which macroeconomic policies mainly focus. After China’s reform and opening up and rapid development of the economy, the inflation pressure in China appears from time to time. Thus to study the formation mechanism of inflation and explore how expectations, inertia and output gap effect the inflation in china, helping the government to make the corresponding fiscal and monetary policies in advance to maintain stable economic growth and reduce the risk of inflation, has significant meanings.Under different levels of inflation rates, each factor has different effect on the formation of inflation. However, most traditional researches are usually based on linear model, which can only obtain the estimates on the conditional mean level and it is difficult to capture the formation mechanism under different levels of inflation rates Based on the new Keynesian hybrid Phillips curve (NKPC) theory with adaptive expectation (backward looking) and rational expectation (forward looking), using the quarterly data from1983to2012, this paper employs the instrumental variables quantile regression (IVQR) method to explore how the formation mechanism of inflation in China changes asymmetrically under different inflation regimes.The empirical results show that there is a significant asymmetric structural characteristic in Chinese Phillips curve and there exists a sharp distinction in the dynamic features of inflation between low and high regime. Under low inflation regime, the inflation rate exhibits significant inertial characteristic and the substitution relationship between output gap (especially the negative gap) and inflation is significantly positive, which confirms the existence of Phillips curve. Under mild inflation regime, the relationship between output gap and inflation is not significant but the inflationary inertia still exists. Under high inflation regime, the inflationary expectation tends to be self-realized but the economy turns into a stagflation period, thus the traditional policy implications of Phillips curve are no longer in force. In addition, after estimating and testing for the benchmark model, we also compare the goodness of fitting for linear regression and quantile regression respectively. The results show that the traditional linear regression method can only capture the formation of inflation on the average level and the explanation ability under extreme cases is questionable. However, quantile regression can provide more information about the dynamic process of inflation formation. Moreover, the estimation on the extended models (distinguishing positive and negative output gap and model for an open economy) indicates the following results: substitution between output and inflation is more significant when the economy lack of effective demand and the inflation level is not very high or at least moderate, when the economy is up going with a positive output gap or in the stagflation period with high inflation and negative output gap, the substitution may be insignificant; for the model in an open economy, after introducing the real effective exchange rate as another explanatory variable, inflation rate and real effective exchange rate have a substitution relationship of the same direction, especially under high inflation regime. Besides, robustness analysis on the estimation results (inflation index selection and instrument variables selection), the variations on the coefficients under different inflation regime are almost consistent, which means the estimation results of the IVQR model are reliable.Finally, this paper has the following conclusions:since the inertia is significant under low inflation regime, the hysteresis effect of the policy is obvious, so the government need to establish monetary policy in advance; since the expectations on inflation is significant under high inflation regime, the government should focus on expectation management, improve the credibility of the government and the central bank, expose the public information, increasing the transparency and enhance the effectiveness of monetary policy, so as to ease the inflation pressure.