Global output gap and domestic inflation in China

Abstract

This paper evaluates whether globalization has led to greater sensitivity of Chinese consumer price inflation to the global output gap. The empirical analysis uses quarterly data over the period 1995-2012. The global output gap is measured by weighted output gap of China?s top eighteen trading partners. Estimating Phillips curve models and vector autoregressive models, we find that global capacity constraints have both explanatory and predictive power for domestic consumer?s price inflation in China. Therefore, the central bank of China should react to developments in global output gaps.