An Empirical Analysis Of Inflation Expectation Traps In China

Firstly, basing on the game theory framework about time inconsistency which developed by Barro and Gordon, we minimize the object in the form of loss of function and describe the formation of inflation expectation traps. We find that although discretionary policy can bring immediate economic stimulus, but in the case of repeated games it will increase the expectations in a retaliatory way, pushing the economy into the equilibria of the largest social loss, which named inflation expectation traps, coexisting high inflation and recession, trapping the government into a dilemma. In the empirical part, the article use the latest quarterly macroeconomic data of the recent 15 years in China, under the applying of markov-switching autoregressive models(MS-AR) and markov-switching vector autoregressive models(MS-VAR),finding that there has been two period Chinese economy slided into the inflation expectation traps, which provided empirical evidence for the Chinese inflation expectation traps hypothesis. Bringing the significant economic and social events occurred in China and the empirical result together, we studied the economic significance, especially in the two inflation expectation traps area. We get further conclusions that from the second quarter of 2005 to the fourth quarter of 2006 is a typical period of Chinese inflation expectation traps. The government has failed to take appropriate policy responses so that the negative impact of this inflation expectation traps was typical and obvious, when real estate prices suddenly rocket rose with the plight of SMEs, and government was trapped into a dilemma that it couldn't control prices while stimulate the economy. 2012 1st quarter- 2015 2nd quarter was another period of inflation expectation traps, the government put forward "Li economics", however, to alleviate the impact of inflation expectation traps on the economy effectively, which brings us a successful case about how to deal with inflation expectation traps. Finally, inspired by these two cases with their own characteristics, combined with the empirical results, we work out four policy proposals for the current economic situation in China.