How does coal price drive up inflation? Reexamining the relationship between coal price and general price level in China

Due to the coal-dominated energy structure, China is currently facing significant economic uncertainties brought forward by instability of coal price. By separating the asymmetric effects that how upward and downward coal price changes pass through to the economy, this paper reexamines the relationship between coal price and general price level in China. The asymmetric effects are investigated via vector autoregression models, Granger Causality tests, and impulse response function analyses using the monthly time series data from Jun-98 to Sep-14. Results show negative coal price change presents more significant impact on inflation than positive one. The inflation responses very abruptly to coal price shock in the short run, but the impact regresses rapidly along time. Accumulatively, a 1% increase of coal price will push CPI and PPI up by 0.04% and 0.12%, while a 1% decrease of coal price will pull them down by 0.08% and 0.17%, respectively. The linkage among coal price change, PPI, and CPI is demonstrated as the main transmission channel of price shock. The inflationary effect is strong in the initial stage, but will be weakened in the later stage since the pass through effect from PPI to CPI is tiny, which confirms PPI is more responsive than CPI to coal price change. For policy implications, how to avoid extreme volatility in general price level is a major concern of recent agendas such as reforming energy market and building green fiscal system.