22 China & World Economy / 22 – 34, Vol. 16, No. 6, 2008 ©2008 The Authors Journal compilation ©2008 Institute of World Economics and Politics, Chinese Academy of Social Sciences Pass-through Effects of Global Commodity Prices on China ’s Inflation: An Empirical Investigation Ligang Liu, Andrew Tsang* Abstract The present paper uses a two-step approach to estimate the pass-through effects of changes in international commodity prices and the RMB exchange rate on domestic consumer price inflation in China. We first estimate the pass-through effects of international commodity prices on producer prices and then estimate the pass-through effects of producer price inflation on consumer price inflation. We find that a 10-percent increase in international commodity prices would lead to China’s producer prices increasing by 1.2 percent 3 months later, which in turn would increase China’s domestic inflation by 0.24 percent over the same period. However, a 10-percent appreciation of the RMB exchange rate against the US dollar would help to reduce increases in producer prices by 4.4 percent over the following 3 months, which in turn would lead to a 0.89-percent decline in consumer price inflation over the same period. Our findings suggest that appreciation of the RMB in an environment of rising global commodity prices and a weak US dollar could be an effective instrument to help contain inflation in China. Key words: China, commodity price, exchange rate, pass-through JEL codes: F3, F4 I. Introduction Since the second half of 2007, inflationary pressure has become the main threat to China’s macroeconomic stability. The consumer price index (CPI) inflation reached a 12-year (year- *Ligang Liu, Chief Economist for China, Research Department, Bank Bilbao Vizcaya Argentaria (BBVA), Hong Kong Branch. Email: lliu@bbva.com.hk; Andrew Tsang, Principal Economist, Research Department, BBVA, Hong Kong Branch. Email: andrew.tsang@bbva.com.hk. The views expressed in this paper are those of the authors alone and do not represent those of the institutions with which the authors are affiliated.