Regional heterogeneity and the provincial Phillips curve in China

This paper explores the presence of regional heterogeneity in the response of inflation to changes in the output gap in China. We estimate the slope of the provincial Phillips curve for four different price indices using quarterly data over the period 2000-2022. The presence of regional heterogeneity is tested by comparing a fixed effects and a mean group estimator. Heterogeneity in the provincial slope is confirmed robustly only in the case of the CPI with around half of provinces exhibiting a positive coefficient. Our findings point to the share of industry and market advancement as significant contributors to the sensitivity of inflation to provincial demand shocks. Moreover, we reveal a relatively low correlation between the national and provincial output gaps as well as inflation rates, which suggests that regional heterogeneity diminishes the effectiveness of unitary monetary policy that targets CPI inflation.