CHAPTER 1

INTRODUCTION

1.1 Relevance of the Thesis

Stabilization policies (demand management policies) are usually, in short-run, applied when an economy is not at its potential level of output. During recession or stagnation, demand–stimulating policies, including expansionary fiscal and monetary policies, are used to boost aggregate demand with an attempt to increase output to its potential level (Konuki, 2000). In recent years, many countries facing recession have been trying to apply these policies (such as Japan, China, Thailand); with the added effect of the September 11^th issue and the continuing quieting of the world economy, these policies are extensively and strongly applied around the world. Nonetheless, the effectiveness of the policies is controversial and differs from country to country.

Since 1998, after a high economic growth period, the Vietnam's economy has experienced a slowdown. Aggregate demand has decreased, reflecting the reduction in investment and consumption. Therefore, since 1999 the government has tried to apply these policies, including expanding government expenditure, loosening credit conditions, cutting interest rates and increasing money supply. The Government has also committed to apply strongly these policies in the year 2002 in order to boost the economy growth through its domestic demand. But the effectiveness of these policies in the last three years is unclear and still under debate. Therefore, it is necessary to have a detailed analysis on the effectiveness of these policies in Vietnam.

1.2 Scope and research questions of the Thesis 

The main objective of this thesis is to seek an answer for the most urgent issue of whether demand-stimulating policies can stimulate the short-run aggregate demand in Vietnam.

This thesis draws on the experiences of Japan, China and Thailand. Japan has applied the policies for over 10 years, the period that is long enough to demonstrate all the possible effects of the policies. However, the policies are argued to be ineffective. Therefore, Japan is a good example for analysis. China is considered relatively successful in demand stimulation. Meanwhile, Thailand, like Vietnam, is a small and developing country, has applied demand-stimulating policies but with limited effectiveness.

Central question:

How effective were the demand-stimulating policies in Vietnam in the period 1999-2001?

Sub-questions:

1.      Under what circumstances are demand-stimulating policies applied?

2.      Which are instruments theoretically used to stimulate aggregate demand and what are their transmission mechanisms?

3.      What lessons can be learned from other country's experiences?

4.      Were the demand-stimulating policies effective in Vietnam in 1999-2001? Why?

5.      Through experiences from other countries and Vietnam, what are the policy implications for Vietnam?

1.3 Methodology of the Thesis

This thesis will be studied by descriptive, comparative and quantitative methods. A comparative method is used to study lessons from other countries. Some econometric models are applied to test the response of aggregate demand's components to the changes in monetary policy in Vietnam.

Data is collected from SBV, MPI, GSO, CIEM, World Bank, IMF, and secondary data from other research. 

1.4 Structure of the Thesis

The thesis consists of five chapters:

Chapter 1. Introduction and relevant of the Thesis

Chapter 2. provides the theoretical basis for the application of demand-stimulating policies, the transmission mechanism of aggregate demand-stimulating policies. Also it indicates theoretical and empirical results that show the limited effectiveness of these policies.

Chapter 3 reviews and broadly analyses the implementation and achievement of demand-stimulating policies in Japan, China and Thailand.

Chapter 4 practically analyses the implementation and effectiveness of demand-stimulating policies in Vietnam in the period 1999-2001.

Chapter 5 concludes the findings and recommends policies for Vietnam.

CHAPTER 2

ANALYTICAL FRAMEWORK

2.1 Stabilization policies: Objectives and Instruments

It is widely accepted that an economy is not always at its potential level in short-run. The economy may be affected by demand or supply shocks. In respect to a demand shock, there are two possible cases, excess demand or deficient demand. When there is an excess aggregate demand, the economy experiences an overheating development period that may cause inflation. In the opposite case, the economy has deficient demand. The shortfall in demand creates a supply surplus in the economy. This would pull the price down, and at least temporarily, cause unemployment because the enterprises response to this deficient demand by cutting production and employment.

In these cases, the target of short-run (stabilization) policies by the government is maintaining full employment, eliminating output gap without high inflation or deflation. Many economists argued that the government should use fiscal and monetary policies, which are generally considered as demand management policies, to achieve these targets. The main instruments of these policies are government spending, taxes, interest rate and money supply, exchange rate. In case of deficient demand, the government may a) increase its spending b) cut taxes c) reduce interest rate or d) increase money supply or e) sometimes exchange rate devaluation. Conversely, with excess demand, the government may increase spending or money supply, raise taxes or interest rate.

2.2 Demand-stimulating policies: Transmission mechanisms 

The policies that are applied when the economy experiences a deficient demand as mentioned above are called demand-stimulating policies. This section will study the transmission mechanisms of their instruments in boosting aggregate demand.

Fiscal policy

Firstly, the government may increase its expenditure (including its investment and purchase) that directly boost the aggregate demand because government expenditure is one component of aggregate demand and if other things are equal. Secondly, many of the same effects on the level of output could be obtained by reducing or repaying taxes.

In addition, changes in government expenditure or taxes are said to have a multiplier effect in aggregate demand. The increase in aggregate demand (expansion in government purchase or household consumption) would boost investment because corporate sector can sell their products. The increase in investment leads to higher employment and household income and consequently more consumption expenditure (higher aggregate demand). These domino effects repeat until that the economy reaches the new equilibrium output.

Monetary policy

To stimulate aggregate demand, the government may also apply easy monetary policy. The state bank may increase money supply or cut its interest rate. In response to the policy, commercial banks may lower interest rates and increase credit to the economy. The lower interest rate would indirectly increase aggregate demand through private investment or consumption.

Firstly, lower interest rate reduces the cost of capital, raising the marginal profit of investors. The increase in availability of credit may create more opportunities for enterprises to borrow from banks. These factors would encourage more business investment.

Secondly, the interest rate is the return rate of household's saving so that lower interest rates mean lower returns of saving. This also indicates the lower opportunity cost of current consumption. At the same time, when interest rate cuts, the current prices of bonds and other assets (the wealth of households) will increase. In addition, credit availability also encourages households to borrow from banks. These may make households to reduce saving and increase consumption.

Exchange rate policy

Theoretically, the government may use exchange rate policy to stimulate aggregate demand through export, import components. If the government devaluates its exchange rate, it will make the prices of domestic products lower in foreign currencies and vice versa the imported goods become more expensive in domestic market. These may encourage export and discourage import, as the result, the net export increases.

However, in practice, this policy is rarely used as active policy due to its uncertain effects, especially in global recession. In addition, it may create difficulties for domestic production if those goods are input ones. In long run, devaluation may create negative impacts on the economy, because the import of technologies from abroad is limited due to high price (Gabriel, 1998). Thirdly, it would increase the government debt to foreign countries in term of domestic currency.

The flexibility of exchange rate plays important role in the effectiveness of fiscal and monetary policy.

Non-fiscal and Non-monetary demand-stimulating policies

Besides of traditional demand-stimulating policies as discussed above, there are some non-fiscal and non-monetary measures that may boost aggregate demand or its components in less developed or transitional economies, which have constraints in access to market, resources or ownership issue.

However, it is noted that these policies can be only applied well in the economies that have above mentioned issues. In addition, ownership reform, regulation changes are argued to be long-run policies, not stabilization ones because it takes time to prepare (to get enough conditions and other reforms) and to apply. They are not quickly adjustable like fiscal, monetary or exchange rate policies. Moreover, their targets are also long-term growth and development.

2.3 Factors that may limit the effectiveness of demand-stimulating policies

2.3.1 Structural weakness and the effectiveness of demand-stimulating policies

It is argued that while every economy has structural problem, some have more structural problems than others do. In this circumstance, the transmission of fiscal and monetary policies is limited.

Firstly, in the production sector, there may be some industries or sectors that are inefficient or over-invested. Besides, the prices of these industry products are normally more expensive than those of similar imported products. Therefore, these products can not compete with imported products and these industries face contracted demand even in domestic market

Secondly, the development and strength of financial system are also important. If the system is underdeveloped or depressed as Mc. Kninon argued, the monetary transmission will be limited (Nguyen 2000, Tran 2001). The demand stimulating policies may encourage enterprises and households to borrow for more investment and consumption but the financial system may not support it

In addition, in the economy, which has structural weaknesses, the demand stimulating policies are not only ineffective, but they also may make the structural weakness more serious in future.

2.3.2 Other constraints to the effectiveness of demand-stimulating policies

Besides the problem of economic structure as mentioned above, theoretically and empirically, some of the following problems may be arisen that threaten the effectiveness of demand-stimulating policies.

Firstly, there are time lags in fiscal and monetary policies. It takes time for the government to recognize a shortfall in aggregate demand, to propose and approve demand stimulation package, especially fiscal policy. In addition, the policies also need time to create effects.

Secondly, the effects of these policies on aggregate demand are uncertain. The government can not estimate exactly the output gap and effect of fiscal and monetary policies on output. This may make the government to be very prudent in applying expansionary fiscal and monetary and sometimes to miss the stimulation opportunity.

Thirdly, the policies may face the issues of crowding out and liquidity trap.

Fourthly, the macroeconomics condition is also an important base for the implementation of demand-stimulating policies. High budget deficit and public debt would not allow the government to expand fiscal policy. Weak financial sector does not support expansionary monetary policy. The poor macroeconomic conditions also affect the behaviors of enterprises and households and make them reluctant to invest and consume.

Fifthly, the high dollarization in the economy may make its monetary policy to be ineffective. Because, dollar is an alternative currency to choose, it has all functions of domestic currency. Therefore, interest rate cut of domestic currency, do not affect households saving. In this case, saving in dollar has relatively high interest rate in term of domestic currency, especially when there is an expectation of devaluation.

2.4 Summary

During the recession period, the government can use many policies, including fiscal, monetary and exchange rate policies and other policies as discussed about. However, fiscal and monetary policies are widely accepted and applied. But structural weakness and other macroeconomic conditions sometimes limit the effects of these policies.

In the economy that has structural problem and under structural reform, demand-stimulating policies may make the structural reform process slower. In addition, exchange rate policy (depreciation or devaluation) may create difficulty for long-run competitiveness and development of that country.

In the next chapter, some empirical evidences are studied to make the issue clearer.

CHAPTER 3

EXPERIENCES FROM OTHER COUNTRIES

In this chapter, three countries are selected as case studies. Japan is considered a special case because its recession has lasted for quite a long time and mainly caused by domestic factors, the situation was not improved even the government has applied many demand stimulation packages. Thailand is a country that was directly affected by the regional financial crisis in 1997. The Thailand's government has applied demand-stimulating policies but the domestic demand did not recover. Also considered a relatively good example of successful countries in applying demand-stimulating policies, China's economic downturn was caused by the global recession and impact of regional financial crisis in region, accompanied by SOEs reform in domestic country. But China kept high economic growth during the global downturn.

3.1 The case of Japan in 1990s

3.1.1 An overview of Japan economic and policy development 

Japan achieved a high economic growth period in the late 1980s, which was then so-called “bubble economy”. After which a protracted slump occurred and has lasted up to the present. From 1986-1989, both equity price and land price rose sharply by 300 percent and 150 percent respectively. In combination with the relative low interest rate, this led to high credit and investment growth. In 1989, following the high equity and land prices, inflation moved upward and the Bank of Japan (BOJ) began to raise interest rate to moderate the inflation. Consequently, GDP growth rate declined sharply, inflation, equity and land price after all moved down.

The over-investment in 1980s and reduction in GDP growth rate in early 1990s consequently caused a fall in marginal capital return. It made enterprises sluggish to invest more so that business investment reduced sharply, the main reason of aggregate demand downturn in 1990s.

In response to the economic downfall, Japan has adopted expansionary fiscal and monetary policies for almost of the 1990s. The overnight call money interest rate declined from a peak of 8.2% in March 1991 to 2% in March 1995 and 0.5% in October 1995 and then to kept closely to zero until now.

Supported by such stimulus policies, economic activities and GDP growth started to move up to the peak of 5% in 1996. However, due to the remained structural weakness and accompanied by tightened fiscal policy by the government in order to keep low budget deficit, the economy was then fallen into the new recession starting at the end-1997. The recession had prolonged for 5 quarters with negative growth rate before turned into positive growth in the first quarter of 1999. These issues indicate the fact that the demand stimulating measures that had only temporary and short-term impacts on the economy.

3.1.2 Effectiveness of stimulus policies in 1990-1996 

The recovery of GDP growth in the period of 1995-1996 was somehow considered as a good impact of stimulus policies by the government. However, the serious slowdown in 1997-1998, proved that such recovery was not sustainable. Despite of increasing GDP growth rate in 1990-1996, the inflation trend was still downward. Besides, the increase in GDP during this time mostly contributed by public spending and investment so that when the government started to reduce its fiscal deficit in 1997, GDP immediately responded and turned into negative growth. Statistically, private investment is the main factor of economic fluctuations in this period. This issue can be explained as follows:

Firstly, the over-investment in the end of 1980s has made the reduction in marginal investment return and business profit of enterprises so that enterprises did not want expand investment even interest rate was cut.

Secondly, the fall in equity and land prices reduced corporate asset and increased the ratio of debt to asset, so as enterprises had to use a large share of their profit to pay for interest of outstanding loans. High debt burden also lead to new NPLs. The balance sheets of banks were deteriorated due to increasing NPLs and overvalued collateral of old loans. Therefore, enterprises could not borrow more and banks were reluctant to increase new loans to protect the risk. The increase in money supply was consequently absorbed by banks for their reserve. In this circumstance, small and medium enterprises (SMEs) who really needed capital, could not borrow.

Thirdly, the prudence in easy monetary policy in this period is also a failure of policy makers in stimulating private demand that did not create aggressive impact on demand.

Fourthly, easy monetary policy in combination with appreciation in exchange rates encouraged capital outflow as well as import.

Fifthly, fiscal stimulus packages created only temporary impacts that did not boost the business activities and consumption due to the low quality of these packages, most of them contained a little of so-called “real water” measures.

3.1.3 Effectiveness of stimulus policies in 1997-2001 

As introduced above, after a peak growth in 1996, Japan experienced its worst recession in the 1990s. The output contracted for five continuous quarters before turned into positive growth in the first quarter of 1999. The government again proposed many fiscal stimulus packages and kept interest rate close to zero. However, the impacts of these policies on the economy are in doubt and there is a debate among economists about whether fiscal and monetary policies can bring the economy back from deflation spiral. The followings can explain. 

Firstly, in this period, the policy options for Japan were limited. The government faced high public debt and budget deficit, as well as a close-to-zero nominal interest rate so that the expansion of fiscal and monetary policies is limited.

Secondly, the bank system that was weakened by the fall of asset price in early 1990s had not been restructured. It still had a high volume of NPLs (see appendix 3) that was not resolved in early 1990s but even added by new ones. So the bank system failed to translate the easy monetary policy into credit supply expansion.

Thirdly, the private sector lost its confidence in the economy so they increase precautionary saving and to reduce current consumption. This was not happened in previous period.

Fourthly, fiscal policy was not effectively applied.

3.2 The case of China

3.2.1 Economic development and Demand-stimulating policies

China did not directly face the financial crisis in Asia in 1997-1998. Like Vietnam, it was just affected by the crisis, added by structural weakness; the economic growth has slowed down since 1997. Investment and consumption also decreased, causing insufficient demand and deflation.

In response to the slowdown, China immediately adopted demand-stimulating policies in 1998, including aggressive fiscal and accommodative monetary policies, but fixed exchange rate regime. Besides, China also concentrated on creating better investment environment for various kinds of ownership, especially SMEs.

Thanks to the policies China remained one of the best performing economies at this time in spite of the global slowdown. GDP growth kept at over 7% and there was a good signal of the expansion in domestic demand.

3.2.2 Effectiveness of demand stimulating policies

China's economic development was phenomenal in 1999-2001. This somehow indicates the effectiveness of demand-stimulating policies. This achievement can be explained by the following arguments.

Firstly, the macroeconomic condition before and during the stimulation period was very good. There was high economic growth, strong government budget.

Secondly, China did not abuse fiscal and monetary policies, especially monetary policy. But concentrate to encourage all ownership business, particularly SMEs. The development of SMEs and various kinds of business help to absorb the workers from SOEs which were reformed and labor from rural areas. Besides, the products produced by this sector were very cheap in comparison to those of other countries so China's competitiveness in the region and the world improved remarkably.

Thirdly, fiscal policy, the best choice of developing countries in stimulating demand when monetary policy is argued ineffective, is applied strongly. Supported by good state budget performance, the fiscal stimulus policy has increased the aggregate demand significantly. In addition, China has used the fiscal stimulus very effectively.

Fourthly, the issue of being a member of World Trade Organization (WTO) has increased investor's and household's confidence on the prospect of China's economy that resulted in more investment and consumption.

3.3 The case of Thailand

3.3.1 Economic recession and demand-stimulating policies

After a high economic growth period in early 1990s, Thailand has fallen into a serious recession in 1997-1998, which caused by the combined currency and financial crisis. The Baht was sharply depreciated due to the lack of confidence in domestic currency and high capital outflow. The confidence of enterprises and households deteriorated seriously, leading to a sharp contraction in private demand.

Supported by International Monetary Fund (IMF), the government had carried out many measures to stabilize the economy, particularly financial system, corporate restructuring, in combination with tightened fiscal and monetary policy. In the last quarter of 1998 and the year 1999, many economic indicators had been improved. GDP growth in 1999 turned up by 4.2%.

Therefore, it was suitable time for Thailand's government adopted demand-stimulating policies. However, the financial system was so ill that the main policy that was selected by the government was fiscal stimulus policy. Meanwhile, monetary policy was just kept accommodative.

However, the economic recovery is still very limited in Thailand in last years. It indicates that the demand-stimulating policies in Thailand did not effective.

3.3.2 Effectiveness of demand-stimulating policies

The unresponsive domestic demand can be explained by some following reasons:

Firstly, the financial system has been seriously damaged by the crisis in 1997-1998, having a burden of high degree of NPLs. Banks became more risk averse so that when enterprises needed loan, banks were reluctant to supply credit in order to avoid more risks. In respect to enterprises, most of them had borrowed loan from foreign resources, directly or through financial intermediates. So that a sharp depreciation of Baht made their foreign loans bigger, worsening the corporate balance sheet. In addition, there was over-investment in early 1990s and the decreasing marginal product of capital so that enterprises were sluggish to increase investment.

Secondly, under the pressure of capital outflow and exchange rate instability, the government can not ease monetary policy. In contrast, the Thailand's government had decided to increase interest rate in 2001. This policy is contrary to demand-stimulating efforts. 

Thirdly, the fiscal stimulus packages were well designed but were not implemented as planned due to the slow disbursement. Moreover, much of fiscal expenditure was cost by the financial restructure so that the net fiscal expenditure for demand stimulation was limited.

CHAPTER 4

EFFECTIVENESS OF DEMAND-STIMULATING POLICIES IN VIETNAM IN PERIOD OF 1999 -2001

4.1 Demand-stimulating policies in Vietnam in 1999-2001

4.1.1 Economic situation before demand-stimulating policies

Along with the progress of economic reform, Vietnam has achieved an impressive record of GDP growth in the mid-1990s, with average 9% per year during 1992-1997. But due to the domestic structural weakness and regional financial crisis, GDP growth rate fell from 8.2% in 1997 to 5.8% and 4.8% in 1998 and 1999, respectively. The aggregate demand declined sharply in both domestic and foreign markets. The growth rate of domestic demand (at 1992 price) declined from 9.4% in 1996 to 1.4% in 1997 and 2.0% in 1998, reflecting the contraction in consumption and investment. This contraction made it difficult for enterprises to sell their products. Therefore, goods in stock increased so corporate profit and household income reduced. Consequently, enterprises did not want to increase investment and households reduced their consumption.

4.1.2 Demand-stimulating policies in Vietnam

Since the second quarter 1999, the Vietnamese government proposed many policies and measures in order to increase the aggregate demand of the economy.

Expansionary monetary policy:

The first effort in easing monetary policy was the interest rate cut. In June 1999, three types of interest rate ceilings were replaced by one type for all maturity with lending rate of 1.15%/month and in October 1999 cut to 0.85%/month. In August 2000, Decision No. 241 & No.243/2000/QD-NHNN changed the interest management regime from interest rate ceiling control to base interest rate. The base interest rate was 0.75%/month with trading band of 0.3% for short-term loan and 0.5 % for medium and long-term loan. This base interest rate then was cut in 2001 to 0.6%. The government also eased the credit condition for all economic sectors, encouraged banks and financial institutions to expand credit, especially to infrastructure development projects, rural and agricultural development and poverty reduction programs.

M2 growth rate increased from 26.1% and 25.5% in 1997 and 1998 to 56.5% and 38.9% in 1999 and 2000 respectively. Credit rose increasingly, its growth rate increased from 16.7% in 1998 to 38.1% and 29.8% in 2000 and 2001.

Fiscal stimulus policy

Firstly, the government increased its spending, particularly capital expenditure, export subsidies, wage in public sector, etc. The government supported rural areas, agricultural households by many measures, such as purchasing rice for temporary storage, providing and rescheduling loans for paddy farmers and rice exporters.

Exchange rate policy:

During the period of 1999-2001 the government did not choose exchange rate as a policy measure to increase net export, as well as aggregate demand.

Non-fiscal and Non-monetary policies:

Vietnam was under reform process to market mechanism. Therefore, excluding from fiscal and monetary policies, Vietnam had applied many other policies in order to expand trade, investment, especially to private sector. Followings are some main policies: First, Vietnam encouraged all sectors to participate in exporting all kinds of goods that are not prohibited by laws. Second, Vietnam tried to improve business environment for private sector.

4.2 Critical analysis of the effectiveness of demand-stimulating policies

4.2.1 Analysis of economic achievement in 1999-2001.

Vietnam's economy has gradually recovered. Despite of the recession in global economy, GDP growth rate increased from 4.8% in 1999 to 6.7% and 6.8% in 2000 and 2001, respectively. The recovery of GDP growth was mostly attributed by domestic demand, the expansion of investment and consumption. However, the GDP growth rate was still 1.5% lower than pre-recession rate. According to estimations by international organizations, like IMF, WB or ADB, the economic recovery of Vietnam was much slower than that stated by Vietnamese authorities. In addition, consumption recovered was more slowly than GDP did.

4.2.2 Effectiveness of demand-stimulating policies in Vietnam

Structural weakness and the effectiveness of demand-stimulating policies

Firstly, Vietnam has structural weakness in both production and financial sector so that demand-stimulating policies are limited to boost aggregate demand.

Secondly, the SOEs reform was implemented very slowly. Meanwhile, this sector is inefficient and hurt hardly by the recession. The number of profit making SOEs reduced from 40.4% in 1998 to 21% in 1999 and total debt of SOEs reached 200,000 billions Dong. It creates difficulty for government budget and demand-stimulating policies as well.

Thirdly, the main impediment of economic growth in 1992-1996 came from private consumption and FDI, which on average contributed over 13% percentage points annually to real GDP growth. Therefore, when FDI reduced sharply due to the regional financial crisis and global slowdown, aggregate demand was contracted. To achieve the pre-slowdown GDP growth, demand stimulating policies have to boost domestic investment to fill up the reduction gap that left by FDI.

Effectiveness of expansionary monetary policy

Theoretically, interest rate reduction and more credit availability would encourage investment and consumption. However, it seemed to be limited in Vietnam in 1999-2001. The issue can be explained by:

Firstly, the expansionary monetary policy was very cautious in 1999-2001. The interest rate cut seems to follow the deflation, but not to be aggressive. Therefore, real interest rate that was calculated by nominal interest rate minus inflation rate increased sharply in the demand-stimulating period. This would discourage private consumption and investment.

Secondly, Vietnam is one of high dollarization economies. Besides, there was an inconsistency in interest rate management between foreign currencies and VND. So that monetary policy was ineffective, especially in case of expectation of depreciation of VND.

Thirdly, the banking and financial systems in Vietnam were underdeveloped and reformed slowly. and only a part of the economy was related to and affected by the operation of banks. So that, monetary policy can not transmit its impact on the economy.

Fourthly, due to structural weakness, banks were beared of high NPLs when SOEs (the main customer of banks) faced its inefficient operation. In this circumstance, banks were reluctant to lend and enterprise did not want to borrow and expand its business investment.

Fifthly, household income is still very low, especially for those in rural areas, so that their saving ratio was low and just for precautionary. In this circumstance, interest rate cut can not make them to reduce their saving.

Effectiveness of fiscal stimulus policy

In principle, in developing countries where the effectiveness of monetary policy in stimulating aggregate demand was limited, fiscal policy is the best choice. However, the implementation of this policy in Vietnam in last years was limited and inefficient. The policy did not play its important role in stimulating the total aggregate demand. Particularly:

Firstly, budget deficit was increased by very little. The budget deficit in 1999 and 2000 were equal to those of 1996 and 1997, the pre-recession years. In addition, the policy was implemented slowly due to many reasons.

Secondly, the fiscal policy was still lacking “real water expenditure”. Many governmental agencies did not implement the task as assigned by the government. For example the program of purchasing rice and coffee for temporary storage, many state-owned enterprises that were assigned the task had used the government fund for other business purposes. In this case the target of this policy that was expected by the government is to increase farmer's income was not implemented. The policy can not increase income of rural households, consequently their consumption. So as, the real effectiveness of fiscal policy on the economy was much less than expected and planned. In addition, a large amount of budget was paid for the reform of SOEs and financial sector, including cost for resolving overdue loan of SOEs, providing registered capital for the four state commercial banks, etc.

Thirdly, the application of Value Added Tax (VAT) in 1999 was a good measure in tax reform process because this will help enterprises to avoid double tax (as the case of revenue tax). However, due to the inconsistency in tax reform, many enterprises had to pay high cumulative tax payment (IOE, 1999). This made their businesses more difficult.

Fifthly, the budget deficit was mostly funded by domestic resources through issuing bond to the economy. Most of bonds were bought by commercial banks. In this case, the increase in government spending would reduce the credit availability in the economy and may crowd out spending of enterprises and households.

Non-fiscal and Non-monetary policies

In contrary to fiscal and monetary policies, other relaxation and improvement in investment climate as discussed above, had archived some significant results. The high increased private investment in 2001 was argued the result of new law on enterprises and improvement in domestic investment environment rather than the effects of fiscal and monetary policies. The number of newly established enterprises increased rapidly since the effectiveness of the law on enterprises in Jan 2000.

Possible long-term effects of demand-stimulating policies

It is argued that these policies may make negative impacts on long-term development. In Vietnam, SOEs and banking sector are under reform. Supported by demand-stimulating policies, the reform process may be slow down. In demand stimulation stage, the supervision on bank system's operation has to relax and many difficult SOEs can borrow loan from banks so as NPLs would be threaten to increase. This is difficult for strengthening the financial system. Under this limitation, structural weakness will be remained in near future and that may cause an other slowdown..

In summary

Briefly, the effectiveness of demand-stimulating policies in Vietnam in 1999-2001 seemed to be limited. The monetary policy was moderately expanded and its transmission mechanism was constrained by the structural weakness represented by the low competitive SOEs and low development of banking system. Meanwhile, fiscal policy, which is considered the best choice for demand-stimulation in developing countries where monetary policy is ineffective, did not expanded much in Vietnam last years due to long lasting high budget deficit. In contrary, non-fiscal and non-monetary policies, which are considered long -run policy has played a significant role in stimulating aggregate demand, especially through private investment. For more concrete conclusion, in the next section some econometric models are used to test the effectiveness of monetary policy on the components of aggregate demand.

4.3 Empirical study

To concretize the above analysis, in this section, two econometric models are run to test the responses of consumption and investment to reduction in interest rate that was the result of expansionary monetary policy.

4.3.1 Testing the impact of interest rate on private consumption.

The model

lnCON_t = µ + blnINCOM_t + g lnDEPO_t + e                (1)

Where:    CON_t is current consumption per capita,

               INCOM_t represents current income per capita,

               DEPO_t is deposit saving interest rate.

Consumption per capita is calculated by private consumption dividing population.

            Income per capita = (GDP – government revenue)/ population

Quarterly data in 1994-2001 are used (quarter 1- 1994 to quarter 1-2001).

On other hand, the behavior of households may be changed in the period 1999-2001 in comparison to that of the whole regression period, so that dummy variable is added. Particularly, the following specification is run by OLS regression method.

 lnCON_t = µ + blnINCOM_t + g lnDEPO_t + dD992 +  gD992*INCOM_t+ lD992*DEPO_t + e      (2)

Where: D992 is a dummy variable that represents the second quarter of 1999, the time marked the application of demand-stimulating policies.

D992 takes a value of 1 for quarters beginning from the second quarter of 1999 (including quarter 2sd of 1999), and D992 takes a value of 0 for quarters before the second quarter of 1999.

The results of estimation

In 1994-2001:     lnCON_t = - 0.208 + 0.614lnINCOM_t  - 0.085 lnDEPO_t

In 1999 -2001:    lnCON_t = - 0.120 + 0.487lnINCOM_t  - 0.002 lnDEPO_t

Analysis of the estimation results

According to the above results, consumption behavior was not statistically stable from 1994-2001. The regression results show that interest rate cut had a very little impact on consumption. Changes in consumption were mostly determined by changes in income. At the same time, the marginal propensity to consume of household decreased that is shown by the reduction of income elasticity of consumption. These results are suitable with the above arguments that during recession period households tend to increase saving rather than consumption and interest rate was ineffective to encourage more consumption.

4.3.2 Testing the impact of interest rate on investment.

The model

Interest rate has theoretically important impact on investment because it is the cost of capital. Besides, investment is effected by the demand in market and economic development. GDP may be the best indicator that represents both demand and economic development.

lnINV_t = µ + blnGDP_t +dlnGDP_t-1 + g lnR_t +  jlnR_t-1 + e                    (3)

Where: INV is current investment by enterprises. GDP is current gross domestic products and R is short run lending rate.

Estimation results

The equation (2) is run by OLS regression and the results are presented as follows:

The equation (3) is run by OLS regression and the results are presented as follows:

              lnINV_t     =   0.0035  +   0.658lnGDP_t  + 0.208lnGDP_t-1 -  0.09 lnR_t-1  + 0.12 lnR_t                  (3')

            P value    (0.999)      (0.041)            (0.459)                 (0.835)      (0.801)       

            Adjusted R-squared:  0.76

lnINV_t   =    - 0.262    + 0.889 lnGDP_t                                           (3'')

            p value    (0.7934)    (0.0000)        

Adjusted R-squared:  0.80

Analysis of the estimation results

Changes in investment were not effected by interest rate cut. So that the effort to increase investment by interest rate cut was ineffective. This is suitable with the above analysis and arguments.

CHAPTER 5

CONCLUSION AND POLICY IMPLICATIONS

5.1 Concluding remarks

During periods of recession, demand stimulating policies are still widely applied. Expansionary fiscal and monetary policies may stimulate the aggregate demand and recover the economy. However, the effectiveness of these policies depends on various factors. By studying the experiences from Japan in the 1990s, and China, Thailand and Vietnam recently, the thesis draws some following findings:

Firstly, the effectiveness of demand stimulating policies depends on the causes leading to recession. If the recession was affected by a global slowdown (what the IMF calls a synchronized recession), it would be mild and quickly overcome, such as the case of China. However, if the main reason for the recession is structural weakness or other domestic factors, such as the collapse of the bubble economy in Japan or financial crisis in Thailand, the recession is serious and demand-stimulating policies become ineffective, especially monetary policy. The policies have only little impact on stimulating aggregate demand and may make more serious structural weaknesses in the near future.

Secondly, the development and strength of the financial system is a decisive factor for the transmission of monetary policy. If the system is less developed or vulnerable, the banks do not support credit expansion and of course monetary policy cannot stimulate investment and consumption.

Thirdly, structural weaknesses in the production sector are always accompanied with the inefficiency or low competitiveness of the corporate sector. In this circumstance, easy monetary policy may not stimulate business investment (such as the case of Japan, Thailand or Vietnam). This is because, interest payment is a small part of production costs and the profit may not increase by this reduction. Meanwhile, enterprises have to face a business slump, low marginal profit, etc due to their inefficiency.

Fourthly, there is no clear evidence that consumption and saving are closely correlated with interest rate. Consumption depends on income and household confidence on future economic development. Therefore, during a recession, households tend to save more for precautionary purposes.

Fifthly, the macroeconomic condition plays an important role in designing and implementing demand stimulating polices.

Sixthly, when the effectiveness of monetary policy is limited, fiscal stimulus policy in combination with structural reform is the best choice.  Fiscal stimulus policy has short run effects, by itself can not support a healthy recovery. Structural reform is needed to utilize efficiently capital and resource, ensuring long term development.

5.2 Policy implications

Based on experiences from other countries and the analysis of Vietnam's economy in 1999-2001, in order to boost the aggregate demand and economic growth as well, Vietnam should:

Firstly, continue to moderately expand fiscal policy but it must be implemented efficiently. The expenditure should concentrate on raising income of rural households. The budget deficit at 4-5% of GDP was manageable and can be expanded little more.

Secondly, the monetary policy should be kept as accommodative policy only because it was ineffective. Besides, this prudent policy ensures the success of financial system and SOEs reforms.

Thirdly, in combination with moderate demand-stimulating policies, Vietnam should concentrate on structural reform, both financial and SOEs sectors, in order to strengthen the financial system and the competitiveness of production sector in the world and domestic market, especially for medium and long term recovery and development.

5.3 Areas for further studies

Due to limited time and data availability, this thesis has just concentrated on the effectiveness of demand-stimulating policies. In order to make the topic completely, some further studies may be proposed.

Firstly, a simultaneous equation can be used to test the effectiveness of the demand-stimulating policies. From simulation scenarios, a policy package can be suggested for Vietnam.

Secondly, if there is data availability, the responses of each economic sector or region to demand-stimulating policies can be tested, such as the response of private investment to interest rate cuts.