The divergence of China’s prices under economic policy uncertainty shock: A time-varying perspective

Abstract

This study investigates the impact of economic policy uncertainty (EPU) on macro price divergence in China. We use the time-varying parameter vector auto regressive model with latent thresholds (LT-TVP-VAR) to examine the nonlinear causality relationship. Our findings suggest when the EPU rises, the demand of investment would decline more significantly than consumption, which exacerbates the divergence between CPI and PPI. While the heterogeneous elasticity of demand and supply for different consumer goods further contributes to the CPI internal divergence between food and non-food prices. Furthermore, macro price divergence responds negatively to international commodity prices and money supply rising. The responds in short term are more significant compared with the medium and long interval. It suggests that policymakers should stabilize policy expectations and reduce the adverse effects of EPU shocks by increasing policy transparency, thereby mitigating macro price volatility.