Output gaps and inflation in Mainland China, February 2006

BIS Working Papers are written by members of the Monetary and Economic Department of the Bank for International Settlements, and from time to time by other economists, and are published by the Bank. The views expressed in them are those of their authors and not necessarily the views of the BIS. Abstract We estimate output gaps using three methods for Mainland China on annual data spanning 1982-2003. The estimates are similar and appear to co-move with inflation. Standards Phillips curves, however, do not fit the data well. This may reflect the omission of some important variable(s) such as the effect of price deregulation, trade liberalisation and /or changes in the exchange rate regime. We reestimate the Phillips curves assuming that there is an unobserved variable that follows an AR(2) process. The modified model fits the data much better and accounts for some of the surprising features of the simple Phillips curve estimates.