A PHILLIPS CURVE FOR CHINA

This paper models Chinese inflation using an output gap Phillips curve. Inflation modelling for the world’s sixth largest economy is a still under-researched topic. We estimate traditional backward-looking as well as partially forward-looking Phillips curves. Using quarterly data from 1988 to 2002, we estimate a vertical long-run Phillips curve for China and show that the output gap and the exchange rate play important roles in explaining inflation. We adjust for structural change in the economy where possible and estimate regressions for rolling sample windows in order to test for and uncover gradual structural change. We evaluate a number of alternative output gap estimates and find that output gaps which are derived from production function estimations for the Chinese economy are of more use in estimating a Phillips curve than output gaps derived from simple statistical trends. The identification of a decreasing exchange rate effect on inflation during a period of large import growth hints at increased pricing to market behaviour by importers. This result is relevant to policies regarding possible exchange rate liberalisation in China