Time-varying effect of international iron ore price on China’s inflation: A complete price chain with TVP-SVAR-SV model

Abstract

This paper employs a time-varying parameter structural vector autoregression with stochastic volatility (TVP-SVAR-SV) model to examine the time-varying impacts of three types of international iron ore price shocks (the supply, special demand and global demand shock) on China’s inflation from a complete price chain perspective. The empirical results indicate that: (1) demand shocks rather than supply shock in iron ore price have strong effects on China’s inflation at each stage, revealing the importance of distinguishing the underlying sources of price shifts; (2) the effects of iron ore price shocks on China’s inflation at the import stage are substantial and gradually decrease along the price chain. Meanwhile, the product prices of upstream industries are greatly influenced by price shocks, but downstream companies fail to shift rising costs to consumers due to demand elasticity; (3) the fluctuations of iron ore price are not driven by China’s inflation or supply but rather by demand factors, which is in line with the theory of super cycle. Based on the findings, policies focusing on decreasing preventive demand should be proposed. Moreover, China ought to increase overseas investment and improve utilization rates of scrap and iron ore to ease imported inflationary pressures.