Abstract
This paper attempts to assess the extent of price transmission between China and the G3, inclusive of exchange rate shocks. First, we investigate the factors explaining China’s price formation and find two long-run relations identified as aggregate price and export price equations with wages, import prices and output gaps as the driving factors. Second, we assess the degree of price dependence between China and the G3 by using a VAR model and find that transmission from Chinese to US prices moves in the same direction, but not so strong in the context of EU and Japan. Regarding exchange rate shocks, currency depreciation in Japan or China depresses US prices reflecting dollar appreciation in the short run. Also, reduced import prices are another channel through which aggregate domestic prices in the G3 remain depressed. This paper suggests that the solution for both the US and China rests mainly on domestic policies and that the exchange rate for the US at least matters little.
