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Abstract

We investigate the effect of a Chinese slowdown on inflation in the euro area and the United States using the NiGEM multi-country model. We construct different scenarios including a fall in Chinese aggregate demand, a commodity price slump, financial market corrections and a devaluation of the renmimbi. While the commodity slump has the strongest impact on inflation, the demand and exchange rate shocks also play a role; on the contrary, financial turbulences have minor effects. Finally, we study the extent to which monetary policy in advanced economies can succeed in reflating the economy following such a Chinese slowdown. The room for central bank interventions is large.

6. Conclusions

The paper investigates, using the NiGEM model, the effects of a Chinese hard landing in the euro area and the United States. After constructing the hard landing scenario, we evaluate the quantitative spillovers arising from each shock, finding that significant disinflationary spillovers could be generated. In particular, absent any response from central banks, the Chinese investment slowdown alone can lower inflation by up to half a percentage point; if the slowdown is coupled with a fall in global commodity prices and a devaluation of the renmimbi, inflation in the euro area and in the US can drop by more than one percentage point below the baseline. Possible financial markets corrections associated with the Chinese slowdown do not significantly impact inflation. Finally, we study whether and by how much a central bank may reduce the fall of inflation following an external shock. We find that, depending on the type of policy tools used and on the concomitant monetary policy reaction in other countries, the central bank can undo up to around 40% of the reduction in inflation in the euro area. These results seem to be particularly relevant in light of the currently low inflationary environment.