Abstract
We establish a two-country DSGE model with a vertical production chain to study the inflation dynamics in China. By introducing multiple layers of price stickiness and shadow economy production to the vertical industrial chain, our model helps to explain dynamic characteristics of inflation. In our model, shocks can not only affect inflations by passing down the production chain through cost channels, but also in the reverse way due to the intermediate demand effect and the investment costs effects. After calibrating and estimating the parameters, the simulation results show that more than 90% of inflation fluctuations in China can be attributed to domestic shocks, among which the domestic monetary shock and final sector technology shock are the most influencing factors in explaining China’s inflation dynamics.
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