Core Inflation Index for China-An Application of Generalized Dynamic Factor Model

This paper applies a new measure on the core inflation index for China which employs a smoothing procedure along the cross-sectional rather than the temporal dimension via the generalized dynamic factor approach. This new index is based on 79 series from the monthly price indices as well as economy indicators and financial variables spanning from 2005 to 2009. Compared with the traditional CPI it has a higher rigidity in distribution and shows stronger inertia on the mean level and less jumpy on the latest innovations in ARMA-IGARGE process. Analysis on the dating of monetary policies in the sample period approves that the core inflation index would enable the monetary policy makers to reach the advisable decision according to a large extending cross sectional dataset that contains more useful information on the price dynamics.