BIS Working Paper Finds China’s Inflation Responds Strongly to Slack and Expectations

A new Bank for International Settlements working paper says China’s inflation appears to respond more clearly to economic slack and inflation expectations than much of the earlier research had suggested, pointing to a more conventional inflation process in the world’s second-largest economy.

The finding matters because it suggests standard models widely used by central banks to analyze inflation may work for China with fewer special adjustments than previously thought. In BIS Working Papers No. 1353, published May 28, Mikael Juselius of the BIS and Wenzhe Li of the ASEAN+3 Macroeconomic Research Office examined “The strength of the inflation-output link in China” using New Keynesian Phillips Curve models, a common framework that links inflation to expected future inflation and the amount of spare capacity, or slack, in the economy. The paper notes that Li worked on it while he was a visiting economist at the BIS.

“We find a strong and stable link between inflation, slack and expectations in China,” the authors said in the paper’s summary.

For their main analysis, the authors used quarterly Chinese macroeconomic data from January 2000 to September 2025, covering 103 quarterly observations. Inflation was measured primarily with the consumer price index, with checks using the producer price index. Economic slack was captured by an output gap measure based on real GDP relative to an HP-filter trend. For inflation expectations, the paper used one-year-ahead Consensus Economics forecasts, aggregated from monthly to quarterly data. The models were estimated with the generalized method of moments, a standard statistical technique in economics.

The paper said the standard New Keynesian framework fits Chinese CPI inflation better than many earlier China studies found. According to the authors, “R-squared is moving from 0.80 in the canonical closed-economy model (1) to a 0.85-0.88 range in the hybrid and open-economy variants (2)-(6).” Across specifications, the coefficient on inflation expectations was about 0.5 to 0.7, the coefficient on lagged inflation was also about 0.5 to 0.7, and the output-gap coefficient was about 0.45 to 0.55. The authors said those output-gap estimates were much larger than values often reported in prior literature, where estimates were frequently below 0.2.

The preferred specifications were hybrid New Keynesian Phillips Curve models, which give roughly equal weight to past inflation and inflation expectations. Adding open-economy factors such as the real effective exchange rate improved the fit only marginally, suggesting the core inflation-slack-expectations relationship carried most of the explanatory power. The results were also robust when the authors used PPI instead of CPI and when they tested alternative slack measures.

That stands in contrast with much of the older literature on China, which often found the Phillips curve weak or unstable. The paper argues that one reason for the stronger results is its focus on the post-2000 period, avoiding earlier years marked by heavier structural change, and its use of direct survey-based inflation expectations instead of indirect proxies. “Our estimates on inflation expectations are in the range of 0.5-0.7 across specifications and broadly aligned with those reported for advanced economies,” the authors wrote.

The paper also stresses important limits. The stronger relationship depends in part on using the post-2000 sample; adding 1990s data weakens the results. The authors also adjusted for extreme COVID-era output-gap movements because those quarters were atypical. And the research is a BIS working paper, not an official BIS policy statement, with the views presented as those of the authors.

Even with those caveats, the paper’s bottom line is straightforward: the authors say the New Keynesian framework appears usable for China without needing special institutional tweaks.