Output And Inflation Effects Of AD Management Policy

Researches on output and inflation dynamics are always the focus of macroeconomics and monetary policy transmission effects which mainly embody in both identification of the real economic fluctuations and interpretation of the causes. The macroeconomic operation is the comprehensive effects of supply and demand aspects, the economic fluctuations therefore must originate from the aggregate demand and supply shocks. Keynesians believe that the aggregate supply and demand shocks are uncorrelated and demand shock has a only temporary effect on output and employment. Thus, macro-control based on Keynesianism emphasizes the aggregate demand management policies primarily oriented toward monetary policy in order to promote economic growth by stimulating the aggregate demand.However, in the post-financial crisis era, the advanced economies, such as the United States, Japan, Britain and the euro zone, successively adopted unconventional monetary policy to deal with economic recession, economic recovery didn’t happen and it posed their concerns about deflation instead. This phenomenon illustrates the aggregate demand management policies aren’t the dominant factor of economic development that it is generally presumed to be, so pure aggregate demand shocks can’t achieve the desired output and inflation effects. The continued drift and weak demand of economy shows that the crux of the problem is the supply side, China’s economic growth has slowed down in recent years and the authorities have repeatedly stressed structural reforms also suggest that the supply side has become the crucial obstacle to economic growth. This requires reassessing the effects of various types of shocks to the economy.Given the demand management policies may lead to changes in the internal structure of the total supply, this paper, differs from previous studies, relaxes the assumptions that demand and supply shocks are unrelated and demand shocks have no long-term effects on output. We analyze the effects of demand and supply shocks on output and inflation in China since1990s by utilizing a bivariate SVAR model. It is founded that aggregate supply shocks are positively affected by the demand shocks and supply shocks play a dominant role in affecting the output level while demand shocks are the main contributor for the variation in inflation. Thus it is suggested that the government should not rely on aggregate demand management policies to stimulate economic growth, but should focus on the supply side to build a medium-to-long term stable growth mechanism.Chapter1of this paper is an introduction which describes the background and significance of the article, then outlines the framework and points out the innovations and shortcomings. Chapter2reviews the Phillips curve (AS curve) theory and introduces the development of the New Keynesian Phillips Curve, then elaborates on the present research status at home and abroad, finds the unrealistic assumption which supply and demand shocks are independent, and points out that the estimation process and the model number of the data in the empirical analysis. Chapter3describes the widespread use of BQ (1989) method, combining with the quarterly data from1992to2013in China,it analyzes the impact of supply and demand shocks on output and inflation under the assumptions of the AD and AS shocks are uncorrelated and AD shocks have no long-run effect on real output. Chapter4utilizes an AD-AS model based on the output gap-inflation form modern Phillips curve (AS curve), relaxes two assumptions of BQ method to built a modified SVAR (structural vector autoregression) model and reassess the role of the impact of supply and demand shocks in China’s economic fluctuations. Meanwhile, it compares the variations of output gap and inflation before and after relaxing the assumptions, then it provides possible reasons whythe demand shocks induce some shocks to aggregate supply. Chapter5summarizes the main conclusions of this study, and gives the corresponding policy suggestions according to the actual condition of China.The innovations of this article:Based on Cover et al.(2006), relaxes the long-term neutral constraints that the aggregate demand shocks have no long-run impact on output, and modifies AS curve (Phillips curve) to weigh the relationship between the output gap and CPI combining with the new Keynesian AD-AS model, and further clarifies the long-term effects of supply and demand shocks on inflation and output. It also shows that demand shocks induce supply shocks can help explain the anomaly in the effect of supply shocks on inflation observed in the BQ model. Among them, we take real GDP and real GDP gap as the representative of the level of output while take year-on-year CPI and month-on-month CPI as inflation in order to avoid the form of data affecting the research results.The shortage of this article:Taking into account the data availability, the data used for empirical study only from1992when National Bureau of Statistics released the quarterly nominal GDP, so it misses the economic situation from the beginning of reform and opening-up to the period before selected; assumes the AS curve is linear, so ignores the change in slope of the Phillips curve (AS curve); only considers the impact of backward-looking expectations of inflation dynamics without considering the role of the forward-looking expectations.