Skip to main content
SpringerLink
Log in

Hong Kong Inflation Dynamics: Trend and Cycle Relationships with the USA and China

  • Chapter
  • First Online:
State-Space Models

Part of the book series: Statistics and Econometrics for Finance ((SEFF,volume 1))

Abstract

This chapter analyzes the trend and cycle movements of Hong Kong inflation. The empirical model is an unobserved component model that is consistent with the New Keynesian Phillips curve and is estimated using Hong Kong, US, and China inflation and output data. The model decomposes Hong Kong inflation into a stochastic trend and a stationary cycle component that is driven by domestic as well as US and China output gaps. The output gaps are treated as latent variables, thus a by-product of estimating the empirical model are measures of the output gaps that are consistent with the New Keynesian Phillips curve for Hong Kong. Empirical results suggest minor evidence that Hong Kong and US inflation rates are related in the long-run, as US trend inflation movements have minimal effects on Hong Kong trend inflation dynamics. Over the short-run horizon, Hong Kong price movements are heavily driven by both the domestic output gap as well as external forces. US and China output gaps have opposing effects on the cyclical movements of Hong Kong inflation, with the coefficients on the China output gap measured at twice as large as those of the USA.

This is a preview of subscription content, log in via an institution to check access.

Access this chapter

Log in via an institution
Chapter
USD 29.95
Price excludes VAT (USA)
  • Available as PDF
  • Read on any device
  • Instant download
  • Own it forever
eBook
USD 129.00
Price excludes VAT (USA)
  • Available as EPUB and PDF
  • Read on any device
  • Instant download
  • Own it forever
Softcover Book
USD 169.99
Price excludes VAT (USA)
  • Compact, lightweight edition
  • Dispatched in 3 to 5 business days
  • Free shipping worldwide - see info
Hardcover Book
USD 169.99
Price excludes VAT (USA)
  • Durable hardcover edition
  • Dispatched in 3 to 5 business days
  • Free shipping worldwide - see info

Tax calculation will be finalised at checkout

Purchases are for personal use only

Institutional subscriptions

Notes

  1. 1.

    To illustrate this point, notice that the widely estimated hybrid NKPC:

    $$\displaystyle{\pi _{t} = (1-\alpha )E_{t}(\pi _{t+1}) +\alpha \pi _{t-1} + kx_{t} +\eta _{t},\ \ 0 \leq \alpha < 1,}$$

    can be rewritten as (5.1) with \(\eta _{t} =\alpha (\pi _{t-1} - E_{t}(\pi _{t+1}))\). It then follows that if α > 0, firms are backward-looking and η t will be serially correlated. The above model is a hybrid NKPC that is derived under the assumption that inflation is stationary. However, as shown in (7), additional leads of inflation beyond t + 1 may enter the NKPC if inflation is assumed to have a unit root. Thus, in the presence of stochastic trend inflation, serial correlation in η t may not necessarily stem from backward-looking price-setting dynamics. Rather, serial correlation in η t may serve as a spurious proxy for additional forward-looking elements.

  2. 2.

    As an alternative to a UC model for real output, a UC model for the unemployment rate can be estimated with the inflation equations instead. The unemployment rate can be specified as a sum of the natural rate, which typically is assumed to follow a driftless random walk, and an unemployment gap, which may follow an autoregressive process. In such a case, the unemployment gap will replace the output gap as the driving variable for inflation in the NKPC specification. For examples of UC models that use the unemployment gap as a measure of economic slack, see (1) and (24).

  3. 3.

    This is similar to (23)’s UC model for US inflation except here, z t is specified as a white-noise process instead of an AR(1) process. However, the empirical findings in (23) suggest that z t follows a white noise process for the post mid-1980s which corresponds to the sample period studied in this chapter.

  4. 4.

    The HP gap is a commonly used measure of the output gap in Phillip curve models for Hong Kong. This is despite the well-known shortcomings of the HP-filter which includes difficulty in identifying the appropriate smoothing parameter as well as high end-sample biases (see (18)). For comparisons with the literature, the one-country model is also estimated with the HP-filtered output gap. In doing so, the one-country model is reduced to (5.3)–(5.5) and (5.8), with the HP gap acting as an observed measure of the output gap. For underlying CPI inflation, the reduced model gives an estimated slope of 0.082 which is smaller in magnitude than the reported slope estimate of 0.379 in Table 5.1. This result is as expected since the HP gap undergoes larger swings relative to the unobserved output gap that is extracted from the one-country model.

  5. 5.

    Long-run price movements in Hong Kong should effectively be tied to the USA through the Linked Exchange Rate System. Nevertheless, there may be many causes for persistent deviations of Hong Kong price dynamics from that of the USA. For example, the relatively high inflation in Hong Kong during the 1990s may be due to favorable export price shocks which hike up the prices of tradables that ultimately impact the prices of non-tradables. The Balassa–Samuelson effect in which the high productivity growth gap between the tradable sector and the non-tradable sector leads to a real exchange rate appreciation that increases prices of non-tradables could also be responsible for Hong Kong’s higher long-term inflation in the 1990s (see (20) and references therein).

References

  1. Basistha A, Nelson C (2007) New measures of the output gap based on the forward-looking New Keynesian Phillips curve. Journal of Monetary Economics 54(2), 498–511

    Article  Google Scholar 

  2. Cheng M, Chung L, Yu I-W (2011) On the estimation of the output gap of Hong Kong. HKIMR Working Paper No. 03/2011

    Google Scholar 

  3. Cheung Y-W, Yuen J (2002) Effects of US inflation on Hong Kong and Singapore. CESifo Working Paper Series No. 700. HKIMR Working Paper No. 03/2001

    Google Scholar 

  4. Christiano L, Eichenbaum M, Evans C (2005) Nominal rigidities and the dynamic effects of a shock to monetary policy. Journal of the Political Economy 113: 1–45

    Article  Google Scholar 

  5. Clarida R, Gali J, Gertler M (2002) A simple framework for international monetary policy analysis. Journal of Monetary Economics 49: 879–904

    Article  Google Scholar 

  6. Clark P (1987) The cyclical component of U.S. economic activity. The Quarterly Journal of Economics 102(4): 797–814

    Article  Google Scholar 

  7. Cogley T, Sbordone A (2008) Trend inflation, indexation, and inflation persistence in the New Keynesian Phillips curve. American Economic Review 98(5): 2101–2126

    Article  Google Scholar 

  8. Dua P, Gaur U (2010) Determination of inflation in an open economy Phillips curve framework: the case of developed and developing Asian countries. Macroeconomics and Finance in Emerging Market Economies 3(1): 33–51

    Article  Google Scholar 

  9. Gali J, Gertler M (1999). Inflation dynamics: a structural econometric analysis. Journal of Monetary Economics 44(2): 195–222

    Article  Google Scholar 

  10. Gali J, Monacelli T (2005) Monetary policy and exchange rate volatility in a small open economy. Review of Economic Studies 72, 707–734

    Article  MathSciNet  MATH  Google Scholar 

  11. Genberg H, Pauwels L (2005) An open economy New Keynesian Phillips curve: evidence from Hong Kong. Pacific Economic Review 10(2): 261–277

    Article  Google Scholar 

  12. Gerlach S, Peng W (2006) Output gaps and inflation in Mainland China. China Economic Review 17(2): 210–225

    Article  Google Scholar 

  13. Gerlach S, Yiu S (2004) Estimating output gaps in Asia: a cross-country study. Journal of the Japanese International Economies 18(1): 115–136

    Article  Google Scholar 

  14. Ha J, Fan K (2002) Price convergence between Hong Kong and the Mainland. Mimeo. Hong Kong Monetary Authority

    Google Scholar 

  15. Ha J, Leung C, Shu C (2002) A small macroeconomic model of Hong Kong. Mimeo. Hong Kong Monetary Authority

    Google Scholar 

  16. Harvey A (1985) Trends and cycles in macroeconomic time series. Journal of Business & Economic Statistics 3(3): 216–227

    Google Scholar 

  17. Harvey A (2008) Modeling the Phillips curve with unobserved components. Cambridge Working Papers in Economics No. 0805. Faculty of Economics, University of Cambridge

    Google Scholar 

  18. Harvey A, Jaeger, A (1993) Detrending, stylised facts and the business cycle. Journal of Applied Econometrics 8: 231–247

    Article  Google Scholar 

  19. Henry O, Summers P (2003) Long swings and the implication for unit root tests: evidence from the Hong Kong deflation. Working Paper. University of Melbourne

    Google Scholar 

  20. Imai H (2010) Hong Kong’s inflation and deflation under the US dollar peg: the Balassa-Samuelson effect or export price shocks? The Developing Economies 48(3): 319–44

    Article  Google Scholar 

  21. Ireland, P (2007) Changes in the Federal Reserve’s inflation target: causes and consequences. Journal of Money, Credit and Banking 39(8): 1851–2110

    Article  Google Scholar 

  22. Jia Y, Sinclair T (2009) Permanent and transitory macroeconomic relationships between the US and China. Working Paper. George Washington University

    Google Scholar 

  23. Kim C-J, Manopimoke P, Nelson C (2013) Trend inflation and the nature of structural breaks in the New Keynesian Phillips Curve. Working Paper, forthcoming, Journal of Money, Credit and Banking

    Google Scholar 

  24. Lee J, Nelson C (2007) Expectation horizon and the Phillips curve: the solution to an empirical puzzle. Journal of Applied Econometrics 22: 161–178

    Article  MathSciNet  Google Scholar 

  25. Liu L, Tsang A (2008) Exchange rate pass-through to domestic inflation in Hong Kong. Working Paper No.2, Hong Kong Monetary Authority

    Google Scholar 

  26. Leung F, Chow K, Chan S (2009) Measures of trend inflation in Hong Kong. BIS Working Paper 49

    Google Scholar 

  27. Romer D (1993) Openness and inflation: theory and evidence. Quarterly Journal of Economics 100: 1169–1189

    Google Scholar 

  28. Stock J, Watson M (2007) Why has U.S. inflation become harder to forecast? Journal of Money, Credit and Banking 39(1): 3–33

    Article  Google Scholar 

Download references

Acknowledgments

The author is grateful for the generous hospitality and financial support provided by the Hong Kong Institute for Monetary Research during the completion of this chapter. Special thanks go to the seminar participants at the Hong Kong Institute for Monetary Research, Michael Cheng at the Hong Kong Monetary Authority for helpful discussions and for providing Hong Kong inflation data, and an anonymous referee for valuable comments and suggestions.

Author information

Authors and Affiliations

  1. Department of Economics, University of Kansas, Lawrence, KS, 66045, USA

    Pym Manopimoke

Authors
  1. Pym Manopimoke
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Pym Manopimoke .

Editor information

Editors and Affiliations

  1. Department of Mathematics and Statistics, University of Missouri at Kansas City, Kansas City, Missouri, USA

    Yong Zeng

  2. Department of Economics, The University of Kansas, Lawrence, Kansas, USA

    Shu Wu

Rights and permissions

Reprints and permissions

Copyright information

© 2013 Springer Science+Business Media New York

About this chapter

Cite this chapter

Manopimoke, P. (2013). Hong Kong Inflation Dynamics: Trend and Cycle Relationships with the USA and China. In: Zeng, Y., Wu, S. (eds) State-Space Models. Statistics and Econometrics for Finance, vol 1. Springer, New York, NY. https://doi.org/10.1007/978-1-4614-7789-1_5

Download citation

Publish with us

Policies and ethics

Search

Navigation