What Causes China's High Inflation? A Threshold Structural Vector Autoregression Analysis

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AbstractChina's astonishing economic growth implies a necessity to understand its inflation. The present paper employs threshold nonrecursive structural vector autoregression analysis to explore the asymmetric effects of macro‐variables on inflation in low and high inflation regimes. The empirical evidence demonstrates, first, that the reactions of inflation to various shocks are inflation‐regime‐dependent and asymmetric. Second, monetary policy influences China's high inflation and adjusting the domestic interest rate in China may be an effective way to control inflation in a high inflation regime, but not in a low inflation regime. In a high inflation regime, a high inflation rate may cause the macro‐policy authorities to increase the domestic interest rate, in an attempt to stabilize high inflation. Third, contrary to expectations, the world oil price is not a strong cost‐push factor in a low inflation regime. Oil price increases may increase inflation in a high inflation regime, but there is no such obvious effect in a low inflation regime. Finally, China's nominal effective exchange rate influences inflation in both low and high inflation regimes. A nominal effective exchange rate appreciation might be effective in controlling domestic inflation in both regimes.