Forecasting Inflation In China

Abstract

China is the world’s second largest economy, has sustained strong growth rates for an extended period of time, and is a prime destination for international investors.  It is therefore important for researchers to correctly forecast key macroeconomic variables, such as economic growth and inflation within the Chinese economy.  Forecasts of inflation, in particular, are important for domestic production, export competitiveness, business planning and for international investors.  A section of the literature has assessed models to explain and forecast inflation – within this literature, the role of deviations of output from equilibrium output (Phillips Curve models specified as output gap models) and the role of monetary policy in explaining inflation in China have been of great interest.  This paper assesses atheoretic and structural models to explain Chinese inflation and tests the forecasting ability of these models.  The findings show that money is not as important in explaining inflation as the output gap.  The output gap approach also provides the best forecasts of inflation for the out-of-sample period 2003-2012.  Models based on past information alone cannot beat the output gap models.