Summary:
Stabilizing growth has become a keyword in China's economy. Inflation and growth are the two primary macroeconomic objectives. According to classical macroeconomic theory, there is a trade-off between inflation and growth, at least in the short run, which is represented by the Phillips curve. The ability of central banks to control inflation depends on the strength of this trade-off. However, since the 1990s, there have been signs of a disconnect between inflation and growth in developed economies. One popular explanation for this disconnect is that the Phillips curves of these economies have flattened. This has led to an intense academic debate on whether and why the Phillips curves have flattened. Most studies show that the Phillips curves in developed economies have indeed flattened. However, a few economists disagree. Some studies explore whether China's Phillips curve has also flattened, with mixed results. This study makes the following contributions. First, most studies use partial equilibrium models to directly estimate various Phillips curves for China. However, this approach may suffer from varying degrees of misspecification and lack robustness. We indirectly analyze the trade-off between inflation and growth using demand shocks and a heteroskedastic monthly structural vector autoregressive model. The results show that inflation and output increase with a one-unit monetary policy shock. The inflation-relative response weakens substantially after 2010, with a significant decrease in the Phillips multiplier. In the robustness tests, the effect of economic policy uncertainty shocks on inflation likewise weakens substantially after 2010, and the primary findings hold in the factor model. Next, we exclude the possibility of a flat aggregate demand curve and find that the central bank's anti-inflationary awareness does not increase after 2010. Thus, the weakening inflation response can be interpreted as a flattening of the Phillips curve. Second, considering that the period during which the Phillips curve flattens corresponds to a general slowdown in the Chinese economy, we argue that the two phenomena are compatible. We introduce knowledge capital accumulation and endogenous total factor productivity into the standard dynamic stochastic general equilibrium model. The results show that monetary policy and physical capital investment shocks are the main factors affecting inflation. The endogenous growth channel amplifies the effect of demand shocks on the output variables but weakens the effect on marginal costs and inflation. The endogenous growth channel negatively affects productivity, weakening the isokinetic relationship between inflation and output growth. The subsample estimation results show that the generalized Phillips curve flattens significantly after 2010 due to the combined effect of the endogenous growth channel and a weak marginal cost pass-through. Our findings have broad implications for macroeconomic regulation and control in China. First, from a monetary policy perspective, the flattening of the Phillips curve eventually leads to a flattening of the aggregate supply curve, which implies that demand shocks play a prominent role and may dominate the economic cycle; therefore, it is beneficial for the central bank to take a Keynesian approach. If growth changes more than inflation, the central bank's objective function should empower growth and employment rather than strictly targeting inflation. A flat Phillips curve also implies a reduction in the central bank's ability to stabilize inflation, or a higher “sacrifice rate.” Ceteris paribus, greater changes in employment and output growth are needed to bring real inflation back on target. Second, from an endogenous growth perspective, more attention should be paid to “cross-cyclical adjustment.” To cope with the complex domestic and external economic environment, the government should make cross-cyclical adjustments and maintain policy continuity and stability. Due to the weakening relationship between inflation and output growth and the medium-to long-term nature of productivity evolution, policymakers should focus on the long-term dynamic equilibrium between growth stabilization and risk prevention, gradually moving away from smoothing out short-term fluctuations to providing medium-to long-term precautionary support. Third, from an inflationary perspective, although upside risks to global inflation remain, the central bank's Monetary Policy Implementation Report points out that China's inflation is largely manageable. Indeed, China's money supply has always matched its economic growth. Moreover, expanding the scope of demand-side policies may positively affect supply and productivity, thereby reducing the inflationary pressure on the economy.
祝梓翔, 高然. 通胀—增长权衡和中国菲利普斯曲线的平坦化[J]. 金融研究, 2022, 509(11): 1-20.
ZHU Zixiang, GAO Ran. The Inflation-Growth Trade-off and the Flattening of the Phillips Curve in China. Journal of Financial Research, 2022, 509(11): 1-20.
Bianchi, F., H. Kung, and G. Morales. 2019. “Growth, Slowdowns, and Recoveries”, Journal of Monetary Economics, 101: 47～63.
[11]
Barnichon, R., and G. Mesters. 2021. “The Phillips Multiplier”, Journal of Monetary Economics, 117: 689～705.
[12]
Baqaee, D., E. Farhi, and K. Sangani. 2022. “The Supply-side Effects of Monetary Policy”, NBER Working Paper, No. 28345.
[13]
Chen, K., J. Ren, and T. Zha. 2018. “The Nexus of Monetary Policy and Shadow Banking in China”, American Economic Review, 108(12): 3891～3936.
[14]
Chang, C., K. Chen, D. F. Waggoner, and T. Zha. 2016. “Trends and Cycles in China's Macroeconomy”, NBER Macroeconomics Annual, 30: 1～84.
[15]
Chang, C., Z. Liu, M. M. Spiegel, and J. Zhang. 2019. “Reserve Requirements and Optimal Chinese Stabilization Policy”, Journal of Monetary Economics, 103: 33～51.
[16]
Coibion, O., and Y. Gorodnichenko. 2015. “Is the Phillips Curve Alive and Well After All？ Inflation Expectations and The Missing Disinflation”, American Economic Journal: Macroeconomics, 7(1): 197～232.
[17]
Del Negro, M., M. Lenza, G. E. Primiceri, and A. Tambalotti. 2020. “What's Up With The Phillips Curve？”, Brookings Papers on Economic Activity, 2020(1): 301～373.
[18]
Del Negro, M., M. P. Giannoni, and F. Schorfheide. 2015. “Inflation in The Great Recession and New Keynesian Models”, American Economic Journal: Macroeconomics, 7(1): 168～196.
[19]
Davis, S. J., D. Liu, and X. S. Sheng. 2019. “Economic Policy Uncertainty in China Since 1949: The View from Mainland Newspapers”, Working Paper.
[20]
Justiniano, A., G. E., Primiceri, and A. Tambalotti. 2010. “Investment Shocks and Business Cycles”, Journal of Monetary Economics, 57(2): 132~145.
[21]
Lenza, M., and G. E. Primiceri. 2022. “How to Estimate a VAR After March 2020”, Journal of Applied Econometrics, 37(4): 688～699.
[22]
McLeay, M., and S. Tenreyro. 2020. “Optimal Inflation and The Identification of The Phillips Curve”, in NBER Macroeconomics Annual, 34 (1), Eichenbaum, Hurst, and Parker.
[23]
Mavroeidis, S., M. Plagborg-Møller, and J. H. Stock. 2014. “Empirical Evidence on Inflation Expectations in The New Keynesian Phillips Curve,” Journal of Economic Literature, 52(1): 124～188.
[24]
Stock, J. H., and M. W. Watson. 2020. “Slack and Cyclically Sensitive Inflation”, Journal of Money, Credit And Banking, 52(S2): 393～428.
