Inflation In China Case Study

Inflation, defined as a sustained increase in the overall price level for goods and services, is measured as annual percentage increase in Consumer Price Index (Samuelson and Nordhaus, 1995). Inflation has always been a major macroeconomic challenges for Asian economies. (Osorio and Unsal, 2013). Inflation has huge influence on many aspects of a country, including purchasing power, consumption and investment, financial market, domestic monetary policy and so on. Therefore, it is of great importance to study the behavior of inflation, especially the principal determinants of inflation. Policy makers have to consider inflation properly and determine appropriate monetary policies.

As China has become increasingly important to the world’s economy

In the case of China, several scholars had conducted researches on finding the factors that affect the inflation rate in China. Huang et al. (2010) concluded that inflation rate is positively affected by excess liquidity, output gap, stock prices and housing prices. They also pointed out that real interest rate and exchange rates have weak effect on inflation. He and Fan (2015) proposed that there are 15 indicators could affect inflation rates, including currency, quasi-money, domestic short-term loans for financial institutions, total loans of financial institutions, interbank offered rate, gross domestic product, the output gap, industrial added value, fixed assets investment of the tertiary industry, total retail sales of consumer goods, agricultural production price index, the growth rate of the nominal international oil price index as well as Shanghai composite index

It transforms a large number of variables into a much smaller set of components to explain essential information contained in the variables by grouping highly correlated variables, according to Leech et al. (2005) There are several studies apply dimension reduction techniques in their analysis with large data sets, including Artis, Banerjee, and Marcelino(2001), Bernanke and Boivin (2003), Lin and Tsay (2005) and Mehrotra and Schez-Fung (2008). Fatoki and David (2010) point out that principal components retained are determined by percentage of the variance covered for the variables, each principal component’s absolute variance accounted.

Brave and Butters (2011) interpreted the way how to monitor the stability of the financial system through combining different indexes which have domination in the whole market into a new total index. As the data base is so large, they use the principal component analysis approach; because the benefit of PCA is its ability to determine the individual importance of a large number of