Abstract: Based on the decomposition of money supply and the money market equilibrium, the foreign exchange market pressure is defined, and then the theoretical model is set up to examine the relationship between the foreign exchange market pressures and inflation. GMM and VAR methods are employed to make empirical studies on inflation in China from January 2000 to December 2012. The GMM evidence shows that domestic credit, the foreign exchange market pressure and United States price influence inflation positively, the real exchange rate has negative impact on inflation, foreign exchange market pressure and bank credit growth are important factors to determine the inflation. From the results of the VAR model, the impact of the foreign exchange market pressure on inflation is also significant. Evidence from the impulse response function and the variance decomposition suggests the shocks to bank credit will lead to the increase in inflation; and the shocks to foreign exchange market pressure can result in higher inflation. The foreign exchange market pressure plays an important role in domestic inflation, and the findings imply that the central bank can control inflation through a combination of exchange rate policy and credit policy.
Keywords: Exchange Market Pressure (EMP), Inflation, GMMVAR Model
source:Finance & Trade Economics ,No11,2013