Understanding the evolving inflation process in China: 1997–2011

• We construct a multivariate dynamic model for inflation dynamics in China.
• We use quarterly data that spans 1997–2011.
• We find that inflation is a monetary phenomenon in China.
• China's exchange rate surrender system is related to its monetary expansion.

This paper analyzes the evolving inflation process in China from 1997 to 2011. We construct a multivariate dynamic framework that captures the features of interactions between inflation and other relevant variables in China. Empirical results show that excess liquidity holds the most important predictive power on inflation in China. Further investigation demonstrates that there is significant pass-through effect from exchange rates and import prices to domestic inflation. We conclude with several significant policy implications that are drawn from our findings.