Time-varying transmission effects of external shocks into inflation: how different is China from Korea?

This article examined the time-varying effects of external shocks that determine inflation on Chinese and Korean consumer price index (CPI) inflation, using data from the period 2010:1 to 2013:4. For this experimentation, we adopted the Kalman filter algorithm. Key findings include the following: first, the lagged CPI inflation is the main determinant of inflation rate in both China and Korea that is significant and has positive effects. Second, as expected, the effects of independent variables on CPI inflation rate have a considerable difference in China and Korea from the coefficients’ size and sign. Especially, China’s CPI inflation is mainly affected by domestic output growth, while Korea is more readily affected by external shocks. Third, we confirmed the time-varying effects. For instance, the positive effect of the output variable is decreasing in the Chinese inflation equation, but its negative effect is decreasing in the Korean inflation equation. Finally, we can guess Korea is a more import dependent economy than China and also the trends of estimated coefficients of China’s inflation are changing similarly to Korea. It has been proved from recent changes that there is a decreasing effect of output growth, but negatively and increasing effects of exchange rate and import dependence. Hence, those recent changes imply that this is caused by the change of the Chinese economy to be more trade dependent as well as we cannot deny the possibility of the external factors that play a role in CPI inflation, and its influence is gradually increasing in China.