China's inflation dynamics fit New Keynesian framework
A new Bank for International Settlements (BIS) working paper finds that China's inflation dynamics fit the New Keynesian Phillips Curve framework surprisingly well. The study by Mikael Juselius and Wenzhe Li reveals a stable and significant link between inflation, economic slack, and expectations, challenging prior research.
Unpacking China's Phillips Curve
Researchers Mikael Juselius and Wenzhe Li systematically investigated China's inflation, economic slack, and expectations through the New Keynesian Phillips Curve (NKPC) lens.
Extending existing research, they employed inflation expectations from Consensus Economics over recent samples and assessed the stability of estimates.
Despite China's unique and evolving institutions, NKPC estimates are stable and show significant roles for both the output gap and inflation expectations, a contrast to previous findings.
Incorporating open-economy variables marginally enhanced model performance.
The results suggest the New Keynesian framework can be adopted to China without adjustments for specific institutional features, providing a robust fit for policymakers.
Overcoming past challenges
Previous studies on the New Keynesian Phillips Curve (NKPC) for China often yielded mixed and weak results, primarily due to methodological and data limitations.
Many relied on older data, spanning periods of rapid economic and institutional change that complicated the inflation-output relationship.
A key challenge was the absence of publicly available inflation expectations, leading researchers to impose strict rational expectations, which can introduce bias.
Additionally, few studies adequately incorporated open-economy variables despite China's growing global trade integration.
These issues hindered the establishment of a stable empirical mapping for Chinese inflation dynamics.
A robust framework for Beijing
The robust fit of the New Keynesian Phillips Curve for Chinese inflation offers policymakers a reliable analytical baseline.
This implies that anchoring inflation expectations through consistent policy and clear communication is crucial, while also highlighting the effectiveness of measures targeting the output gap.
Moreover, the study underscores the significant role of external conditions and exchange-rate management in shaping domestic inflation dynamics.