Journal of Financial Research, 201, Issue 10

Authors: Lyu Yue, Sheng Bin

Abstract: The paper re-estimates the output-gap-based Phillips Curve under open economy condition by system GMM estimation method with the quarterly provincial panel data of China during 2001 and 2009. Through the robustness test of three kinds of inflation index and four kinds of filter estimation of output gap, it is found that hybrid Philips Curve under open economic condition can better explain the price fluctuations in China. Sub-sample analysis shows that adaptive and rational expectations have a significant impact on the inflation in China. From the geographical perspective , the supply shock to inflation is significantly higher in the coast area than in-land area, while the output gap is more important in the inland area. From the time perspective, the effects of both output gap and supply shocks on the inflation are increasing. The research indicates that managing inflation expectations is essential for the current anti-inflation policy. While emphasizing on the use of traditional means of demand management to achieve domestic macro-economic equilibrium, the government should also pay a close attention to the exteral supply shocks on China's macro-economic stability.

Key Words: Phillips Curve, Hybrid expectation, Output gap, External shock