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Developing an underlying inflation gauge for China

Listed author(s):
  • Marlene Amstad
  • Ye Huan
  • Guonan Ma

The headline consumer price inflation (CPI) is often considered too noisy, narrowly defined, and/or slowly available for policymaking. On the other hand, traditional core inflation measures may reduce volatility but do not address other issues and may even exclude important information. This paper develops a new underlying inflation gauge (UIG) for China which differentiates between trend and noise, is available daily and uses a broad set of variables that potentially influence inflation. Its construction follows the works at other major central banks, adopts the methodology of a dynamic factor model that extracts the lower frequency components as developed by Forni et al. (2000) and draws on the experience of the People's Bank of China in modelling inflation. The paper is the first application of this type of dynamic factor model for inflation to any large emerging market economy. Our UIG for China is less noisy but still closely tracks the headline CPI. It does not suffer from the excess volatility reduction that plagues traditional core inflation measures and instead provides additional information. Finally, when forecasting the headline CPI, our UIG for China outperforms traditional core measures over different samples.

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Paper provided by Bank for International Settlements in its series BIS Working Papers with number 465.

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Length: 29 pages
Date of creation: Sep 2014
Handle: RePEc:bis:biswps:465
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  1. Forni, Mario & Hallin, Marc & Lippi, Marco & Reichlin, Lucrezia, 2005. "The Generalized Dynamic Factor Model: One-Sided Estimation and Forecasting," Journal of the American Statistical Association, American Statistical Association, vol. 100, pages 830-840, September.
  2. Domenico Giannone & Lucrezia Reichlin & Luca Sala, 2005. "Monetary Policy in Real Time," NBER Chapters,in: NBER Macroeconomics Annual 2004, Volume 19, pages 161-224 National Bureau of Economic Research, Inc.
  3. James H. Stock & Mark W. Watson, 2008. "Phillips curve inflation forecasts," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 53.
  4. Xiaojing Zhang, 2012. "China's Inflation: Demand-Pull or Cost-Push?," Asian Economic Papers, MIT Press, vol. 11(3), pages 92-106, Fall.
  5. Marlene Amstad & Andreas M. Fischer, 2009. "Are Weekly Inflation Forecasts Informative?," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 71(2), pages 237-252, April.
  6. Eric Girardin & Sandrine Lunven & Guonan Ma, 2014. "Inflation and China's monetary policy reaction function: 2002-2013," BIS Papers chapters,in: Bank for International Settlements (ed.), Globalisation, inflation and monetary policy in Asia and the Pacific, volume 77, pages 159-170 Bank for International Settlements.
  7. Amstad, Marlene & Potter, Simon M. & Rich, Robert W., 2014. "The FRBNY staff underlying inflation gauge: UIG," Staff Reports 672, Federal Reserve Bank of New York.
  8. Boivin, Jean & Ng, Serena, 2006. "Are more data always better for factor analysis?," Journal of Econometrics, Elsevier, vol. 132(1), pages 169-194, May.
  9. Mehrotra, Aaron & Peltonen, Tuomas & Santos Rivera, Alvaro, 2010. "Modelling inflation in China--A regional perspective," China Economic Review, Elsevier, vol. 21(2), pages 237-255, June.
  10. Altissimo, Filippo & Bassanetti, Antonio & Cristadoro, Riccardo & Forni, Mario & Hallin, Marc & Lippi, Marco & Reichlin, Lucrezia & Veronese, Giovanni, 2001. "EuroCOIN: A Real Time Coincident Indicator of the Euro Area Business Cycle," CEPR Discussion Papers 3108, C.E.P.R. Discussion Papers.
  11. Marlene Amstad & Andreas M. Fischer, 2009. "Do macroeconomic announcements move inflation forecasts?," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 507-518.
  12. Chang Shu & Andrew Tsang, 2005. "Adjusting For The Chinese New Year: An Operational Approach," Working Papers 0522, Hong Kong Monetary Authority.
  13. Mario Forni & Marc Hallin & Marco Lippi & Lucrezia Reichlin, 2000. "The Generalized Dynamic-Factor Model: Identification And Estimation," The Review of Economics and Statistics, MIT Press, vol. 82(4), pages 540-554, November.
  14. Changyong Rhee & Hangyong Lee, 2013. "Commodity price movements and monetary policy in Asia," BIS Papers chapters,in: Bank for International Settlements (ed.), Globalisation and inflation dynamics in Asia and the Pacific, volume 70, pages 71-77 Bank for International Settlements.
  15. Zhang, Chengsi & Clovis, Joel, 2010. "China inflation dynamics: Persistence and policy regimes," Journal of Policy Modeling, Elsevier, vol. 32(3), pages 373-388, May.
  16. Zhang, Chengsi, 2011. "Inflation persistence, inflation expectations, and monetary policy in China," Economic Modelling, Elsevier, vol. 28(1-2), pages 622-629, January.
  17. Cogley, Timothy, 2002. "A Simple Adaptive Measure of Core Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(1), pages 94-113, February.
  18. Cristadoro, Riccardo & Forni, Mario & Reichlin, Lucrezia & Veronese, Giovanni, 2001. "A Core Inflation Index for the Euro Area," CEPR Discussion Papers 3097, C.E.P.R. Discussion Papers.
  19. Amstad, Marlene & Fischer, Andreas M., 2010. "Monthly pass-through ratios," Journal of Economic Dynamics and Control, Elsevier, vol. 34(7), pages 1202-1213, July.
  20. Burdekin, Richard C K & Hu, Xiaojin, 1999. "China's Experience with Indexed Government Bonds, 1988-1996: How Credible Was the People's Republic's Anti-Inflationary Policy?," Review of Development Economics, Wiley Blackwell, vol. 3(1), pages 66-85, February.
  21. Domenico Giannone & Troy D. Matheson, 2007. "A New Core Inflation Indicator for New Zealand," International Journal of Central Banking, International Journal of Central Banking, vol. 3(4), pages 145-180, December.
  22. Carsten A Holz & Aaron Mehrotra, 2013. "Wage and price dynamics in a large emerging economy: The case of China," BIS Working Papers 409, Bank for International Settlements.
  23. Claudio E. V. Borio & Andrew Filardo, 2007. "Globalisation and inflation: New cross-country evidence on the global determinants of domestic inflation," BIS Working Papers 227, Bank for International Settlements.
  24. Marlene Amstad & Ye Huan & Guonan Ma, 2014. "Developing an underlying inflation gauge for China," BIS Working Papers 465, Bank for International Settlements.
  25. Marlene Amstad & Simon M. Potter, 2009. "Real time underlying inflation gauges for monetary policymakers," Staff Reports 420, Federal Reserve Bank of New York.
  26. Nagayasu, Jun, 2009. "Regional Inflation in China," MPRA Paper 24722, University Library of Munich, Germany.
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