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Introduction I.
Background and relevance of the topic Inflation
re-emerged in 1990 and 1991, up to 67.5% and 67.6%, respectively. In 1992, it
was at 17.5% and fell to 5.2% in 1993. Then, it rose to 14.4% in 1994 and to
12.7% in 1995. It fell fast to 4.5% in 1996, to 3.6% in 1997, up to 9.2% in
1998. It is evident that higher inflation
rate tends to be associated with lower growth rate. However, In 1999 Vietnam
faced a new and great challenge: a sharp fall in inflation rate (to 0.1%),
accompanied by a low economic growth rate (4.8%). The issue of too low
inflation is now at the center of much debate among economists. The debate about appropriate macro policy
responses has raised questions about main factors involved in inflation and
whether the magnitude of these factors determining inflation has been stable or
not in Vietnam during 1991-1999.
II. Focus and scope of the thesis
To investigate the fundamental determinants of
inflation in Vietnam by the model.
To recommend macroeconomic policy implications
within the new circumstances.
To examine determinants of inflation in Vietnam
from January 1991 to May 1999. III.
Research questions 1. What are fundamental determinants of
inflation in Vietnam during 1991 - 1999 ? 2.
Has the magnitude of the determinants of inflation stabilised during
1991-1999? 3.
What are macroeconomic policy implications concerning Vietnam determinants of
inflation in the context of the goal of achieving high economic growth? IV.
Methodology of the thesis The main method of analysis used to study
the inflation is the quantitative method. Monthly
secondary data in the thesis is provided by the CIEM, SBV, GSO and IMF V.
Structure of the thesis Chapter 1
presents theoretical foundation of inflation and two empirical evidences. Chapter 2
presents the financial reform & the
evolution of the inflation in Vietnam. Chapter 3
quantitatively analyzes the determinants of inflation during 1991 - 1999. Chapter 4
summarizes the primary findings & macroeconomic
policy implications. Chapter
1: Theoretical framework 1.1. Definition, Measurement and Classification of
Inflation Inflation is a process of continuously
rising prices, which are measured by CPI. Inflation rate measurement is also
calculated as follows: pt = (Pt
-Pt-1)*100/ Pt-1. Three main types: demand-pull
inflation, cost-push inflation, structural inflation. 1.2. Structuralist Approach to Inflation Causes: inelastic supply of foodstuffs,
foreign exchange and budget constraint. Inflation is seen to be unavoidable in
an economy attempting to grow very fast. 1.3.
Monetarist Approach to Inflation
Causes: a rise in money supply in
classical money quantity theory: M´V = P´ Y and based mainly on the quantity
function of Monetarist theory: P´Y = (1/k) ´ M. Inflation is
regarded as the fundamental monetary phenomenon in an economy 1.4. Consequences of inflation Monetarist view: Price stability is a
prerequisite for sustained economic growth. Structuralist view: Inflation is seen as a mean of accelerating economic growth.
Both schools' view: Inverted U_shaped relationship
between inflation & growth. 1.5. methods to fight inflation The Orthodox (
mainly
according to the Monetarists) Approach to fight inflation. The Heterodox ( mainly based on the
Structuralists ) Approach to
fight inflation. 1.6. Theory-based foundation for determinants of inflation Equilibrium condition in money market -Definitional
equation for money velocity 1.7. Empirical
investigation of determinants of inflation Lag technique illustrated by Malaysia's
instance of the determinants of inflation. Cointegration
technique through Negeria's example of determinants of inflation. 1.8. Chapter remarks Applying the
broad monetarist model taking into account structuralist variables. Lag technique used to estimate
Vietnam's distributed-lagged model of inflation. CHAPTER 2: Vietnam's
Financial REFORM AND INFLATION 2.1. Financial reform in Vietnam 2.1.1. INSTITUTIONAL REFORM The reform of financial system in Vietnam is regarded as banking system reform. First basic steps in reforming the banking
system made in mid - 1988 in
Vietnam. Nevertheless, the two - tier banking system
really was established in May , 1990. Moreover, the second steps in the banking
system reform have done since 1992. 2.1.2. MONETARY
POLICY INSTRUMENT REFORM
State Bank of Vietnam still relies
heavily on direct instruments of monetary
policy
Some principal "price-based" instruments are still
very underdeveloped presently.
Five main instruments of monetary policy are the interest
rate, the credit ceilings, the required
reserve ratios, the refinancing facilities and
the
treasury bill auctions.
Financial reform in Vietnam has several positive effects on
the control of inflation.
Source: Thanh (1996);
IMF(1999); CIEM (2000); (Note that: index 1989 = 100). Chapter 3: Econometric evidence of model
specification 3.1. Description
of data 3.2. Empirical model specification and validity 3.2.1.Model Specification
The distributed-lag model of determinants of inflation
during 1991:1-1999:5. Where: p and gM are the inflation rate & nominal money supply growth
rate; gY is the real output growth rate and v is minus
of the rate of return on US dollars circulating in the domestic economy
(percentage) and pe is the
expected inflation rate. Cumulative coefficients of determinants of inflation have
its signs as follows: åaiM > 0, åaiY < 0, åaiv > 0, åaipe > 0. 3.2.2.Unit Root Test for Stationary Augmented Dickey-Fuller (ADF)
tests show that all series: p, gM1, gM2, gY, v are integrated of order zero or stationary at five percent
significance level. Table
8: Unit Root Tests for Stationary.
Note: ADF
critical value at 5 % in the sample
size of 100 is about -2.89 (Maddala,
1992). Source: Author's calculations based on data during
1991:1 - 1999:5 in the model
specification (1). 3.2.3. Lag Lengths of Each Determinant
The lags of the determinants of
inflation in the model (1) are chosen in line with a sequential procedure by
Hsiao (1981) on the basis of Akaike’s FPE. Table 9: The specifications of the
model (1) for the cases of M1 and M2.
List of determinants shows the sequence of the choice
according to Hsiao’s procedure 3.3. Estimation results, hypothesis testing &
interpretation
3.3.1. Results and hypothesis testing during 1991-1999 We use M1, M2 in combination with
e(Office) and e(Market) to divide the model
estimation into four cases. The results are seen in tables 10, 11, 12
and 13. Hypothesis testing for the
estimation results is carefully under consideration. + T-Test for
significance of regression coefficients + LM Test for
Serial correlation + Jarque-Bera Test for Normality + White's Test for
Heteroscedasticity + Ramsey's Reset
Test for Functional Form + Cusum Test and
Chow's test for stability of parameters + Wald Test for S(lag coefficients) =
0 + Wald Test for S(lag coefficients of
gM) = 1 + F-statistic Test
for the joint significant of the lags 3.3.2. Interpretation of the estimation results during 1991-1999 Generally, gM,
gY, p-1, and v in model (1)
are jointly significant at different significance levels 10%, 5% and 1%. Thus,
they are useful predictors in explaining change in inflation rate during
1991:1-1998:12 and 1991:1-1999:5. Basically, gM, gY, v and p-1 have
long-lasting and significant impacts on inflation rate with their signs
consistent with the economic theory's prediction. Compared with the results in table 10,
11 and 13, gY in table 12, apart from its long-lasting negative impacts, has
its impacts on inflation in short duration. In essence, if the gM1 changes at some
time, it will take one or two months for inflation rate to fully adjust to
those changes in Vietnam during this period. If the gM2 changes, inflation will
fully adjust to those changes in that current month or in one or two months
later. In four cases mentioned above, inflation rate is very sensitive to short
lags of the growth of the money supply growth. If v changes at some time in the case of official exchange rate,
it will take one, two, three or four
months for inflation to fully adjust to those changes. If v changes in the presence of the parallel market exchange
rate, it will take three months or five months later for inflation fully adjust
to those changes. Moreover, the maximum impact of the significant lag of v is
approximately four months in the presence of official exchange rate and is
approximately five months in the presence of the parallel market exchange rate.
Based on the
estimation results of the model specification, the impact of the current value
and lag one of gY on inflation in four cases is statistically significant and
negative, as expected. It could mean that the change in real industrial output
is quite appropriate as a proxy for real income in Vietnam. The estimation
results of the model show that all four regressions contain the expected
inflation, pe, as a
determinant of the inflation in Vietnam. It can be seen from all cases that pe is also a
useful predictor of the inflation rate. Such a determinant also has a
long-lasting positive impact on the inflation rate in accordance with
macroeconomic theory's prediction. 3.3.3. Results and hypothesis testing during 1991-1994 and 1994-1999 Because four
regressions in tables 10, 11, 12 and 13 do not pass the test for structural
stability under Cusum test, the stability of estimated parameters in such four
regressions does not exist during 1991:1-1998:12 and during 1991:1999:5. This
instability of the parameters in the model (1) in tables of 10, 11, 12, 13 can
happen in October 1994. Based on
Chow's test in tables 14, 16, 18 and 20, the null-hypothesis of the stability
of the estimated parameters is also rejected.
3.3.4. Interpretation results during 1991-1994 The estimation results of the model
specification (1) during 1991:1-1994:10 are basically similar to those obtained
during 1991:1-1998:12 and 1991:1-1999:5. 3.3.5. Interpretation results during 1994-1999
During
1994:11-1998:12 and 1994:11-1999:5, the estimation results of the model are
basically different from those during 1991:1-1998:12 and 1991:1-1999:5. The gM1 and gM2 have both a less long-lasting
and short-lasting impact on inflation rate during 1994:11-1998:12 and during
1994:11-1999:5. The gY has only a long-lasting negative
impact on inflation rate. Furthermore,
the p-1 was not
jointly significant in explaining the changes in the inflation rate. The coefficients
of all the lags of v and the sum
of its coefficients during 1994:11-1998:12 and 1994:11-1999:5 are not
statistically significant. This suggests that exchange rate have no significant
effects on inflation. The (deposit) interest rate policy has a less significant
impact on inflation rate.
3.4. Macroeconomic Policy Implications This thesis
finds that expected inflation possesses the valuable information of the price
behaviour in the long run. Thus, firm commitment to controlling low and stable
inflation should be a starting point in policy formulation to consolidate
credibility in economic policies and the domestic currency and lower likelihood
of high inflation in the future. In the context of too low inflation, more
attentions should be paid to readjusting and controlling inflation at more
reasonable levels (higher than 3 % and lower than 10 % per year, such as 6% or
7% in chart 10) with the aim of promoting high and sustained economic growth in
Vietnam. This thesis
finds that nominal money supply
growth (including gM1, gM2) is positively and significantly related to the
inflation rate in Vietnam in the long run. Therefore, to sustain a low and
stable inflation rate, it is best to provide the SBV greater autonomy in
formulating and implementing monetary policy. In the long run, money supply
management should be under prudent control by the SBV based on both demand and
supply side. This thesis finds that the return rate
on US dollars possesses the price behaviour information in the long run. The
relation between the changes in exchange rate and (deposit) interest rate
substantially affects a policy toward promoting VND. Such changes should be
sustained reasonably so that inflation can be adjusted to this effort. Also, an
active interest rate policy should be seen as a one not only of guaranteeing a
just positive deposit interest rate in real terms, but of also taking into
account the depreciation rate and interest rate for dollar deposits. Thus, the
SBV's efforts to make VND more attractive via interest rate/exchange rate
policies should be sustained to be higher effective to keep low inflation. This research finds that the magnitude of the determinants
of inflation has changed greatly during 1991-1999. It is regarded as one of the
main findings and very meaningful for Vietnam's policymakers. It also means
that it is necessary and useful to modify some used macroeconomic policies to
timely meet big changes in the Vietnam's economy presently. + Because one of Vietnam's most important goals in 1995-2000
is to obtain high growth, tight monetary policy in past years is not favourable
for this goal. The loosened money supply performance in the short run has a
less significantly positive impact on inflation compared to its performance in
the long run. With new goal of high growth, in the short run the SBV should
loosen its money supply management to stimulate demand in the context of
''too'' low inflation. + Besides, although the direct monetary
instruments are effective in controlling inflation, these may be harmful to the
banking business. Thus, the SBV should enhance the use of indirect monetary
policy measures. The reform of the credit policy is one priority. +
An
active interest rate in defending VND is needed since it acts along with tight
fiscal and monetary policy to form people's credibility in State's efforts to
control inflation. Still, high deposit interest rates cause higher loan
interest rates harmful for economy. SBV should manage interest rate policy
(positive real terms) flexibly to promote high growth. Exchange rate
has an insignificantly impact on inflation since November 1994. Hence, the
devaluation of VND has insignificantly affected changes in inflation.
Therefore, in the short run, the State Bank of Vietnam should carry out more
flexible exchange rate policy to raise Vietnam's competitiveness, helping
stimulate demand without fear of a significant rise in inflation. Moreover, in
the long run, it will be useful to relax the rigid exchange rate policy by the
State Bank. There are two principal ways to enhance the effectiveness of its
exchange rate management policy. The first is to introduce a basket of major
trading partner currencies as a nominal anchor instead of only the US dollar.
The second is that by widening the band, the VND can fluctuate more freely to
reflect the market condition.
Source: Author's calculation based on data collected from IMF (1991,
1999), Thanh (1996). Chapter
4: Conclusion 4.1. Summary
of main findings The thesis investigates crucial determinants of inflation
based on a broad monetarist model that accounts for inflation movement due to
changes in money supply and other factors determining the demand for real
balances. The results show that the model (1)
fits monthly data in 1991:1-1999:5 in Vietnam. During 1991:1- 1998:12 and
1991:1-1999:5, gM, gY, p-1 and v are useful
predictors in explaining the change in inflation. Such determinants have a
long-lasting impact on inflation with their right expected signs. In the long run, tight monetary policy
and positively real deposit interest rate policy and careful exchange rate
policy have played an important role in controlling inflation in Vietnam in the
process of further economic reform. In the short run, exchange rate had an insignificant effect
on inflation rate. On the whole, the monetary policy has less significantly
affected the change in inflation rate in Vietnam. 4.2. Policy
recommendations
Firm commitment to controlling and
sustaining low inflation should be a starting point in policy formulation to
consolidate people's credibility in economic policy and VND and lower
likelihood of high inflation in the future. It is best to provide larger autonomy to Vietnam's State
Bank in formulating and implementing monetary policy with the aim of both
keeping inflation reasonable (5-7 % per year) and promoting high economic
growth. In the long
run, monetary policy (money supply& interest rate policy) and exchange rate
policy should be under prudent control by SBV based on demand and supply side,
aiming at keeping inflation low and stabilizing macroeconomic climate. In the short run, SBV should
greatly loosen its monetary policy, especially money supply management policy
within the context of too low inflation. SBV should carry out its more flexible
exchange rate policy with the aim of stimulating demand, without the fear of
causing high inflation in Vietnam. Outline
for estimating the model in vietnam
Table 10: Estimation result in case of using M1
and e Office for Vietnam: 1991:1-1998:12
Note
that: *, **, and *** denote the
significance at the 10%, 5%, and 1% levels, respectively. The figures in parentheses mentioned above
are t-ratios; Model's equation in
Vietnam in 1991:1-1998:12. (Case
of M1 and e Office). Source: Author's calculations based on data during
1991:1-1998:12 (monthly data) in the model (1). Table 11: Estimation result in case of using M2
and e
Office for Vietnam: 1991:1-1998:12
We note
that: *, **, and *** denote the
significance at the 10%, 5%, and 1% levels respectively. The figures in parentheses mentioned above are
t-ratios; Model's
equation in Vietnam in 1991:1-1998:12. (Case
of M2 and e Office). Source:
Author's calculations based on data during 1991:1-1998:12 (monthly data)
in the model (1). Table 12: Estimation result in case of using M1
and e Market for Vietnam:
1991:1-1999:5
We note
that: *, **, and *** denote the
significance at the 10%, 5%, and 1% levels respectively. The figures in
parentheses mentioned above are t-ratios; Model's
equation in Vietnam in 1991:1-1999:5. (Case
of M1 and e Market). Source: Author's
calculations based on data during 1991:1-1999:5 (monthly data) in the model
(1). Table 13: Estimation result in case of using M2
and e Market for
Vietnam: 1991:1-1999:5
We note
that: *, **, and *** denote the
significance at the 10%, 5%, and 1% levels respectively. The figures in
parentheses mentioned above are t-ratios; Model's
equation in Vietnam in 1991:1-1999:5. Source: Author's calculations based on data during
1991:1-1999:5 (monthly data) in the model (1).
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