China inflation dynamics: Persistence and policy regimes

Abstract

Inflation in China has been remarkably stable during the last decade, a dramatic shift from the pattern seen in the prior two decades, and so questions arise as to whether inflation dynamics has also changed, and if so, what has caused the change and what are the policy implications? This paper explores these important questions and finds that the persistence of inflation dynamics in China experienced a significant reduction in the late 1990s. By using counterfactual simulations we show that systematic monetary policy change is the main contribution to the observed structural change. Our result implies that although inflation is less persistent and hence less responsive than it used to be to shocks, monetary authorities must be vigilant in monitoring potential inflation rise and to take preemptive action to anchor inflation expectations against any indication that they may rise in the coming periods.