Inflation Dynamics and an Extended New Keynesian Phillips Curve for China

This paper shows that the error term in the stylized New Keynesian Phillips curve (NKPC) model for China is significantly serially correlated. We propose an extended NKPC model for China, which can be easily rationalized in terms of sticky-price setting of backward-looking firms. Empirical results show that further lags of inflation are needed in the hybrid specification of the NKPC in order to rule out serial correlation; forward-looking behavior has a relatively larger impact on inflation dynamics than backward-looking behavior; and conventional output measures remain valid inflation forces in the extended model. Open economy augmentations, nevertheless, indicate that neither exchange rate nor import prices exert a significant impact on inflation in China.