ASSIGNMENT SUBJECT MACROECONOMICS topic inflation and the rationality of the quantity theory of money in vietnam

NATIONAL ECONOMICS UNIVERSITY

Faculty of Mathematical Economics============

ASSIGNMENT SUBJECT : MACROECONOMICS

Topic: Inflation and The rationality of

The Quantity Theory of Money in Vietnam

Full name: Le Bao Trung

I Introduction 3

II Theory 3

1 Money Growth 3

1.1 Demand for Money 3

1.2 Supply for Money 4

2.3 Cost of expected inflation 7

2.3.1 A fall in purchasing power 7

2.3.2 Shoeleather Costs 7

2.3.3 Menu Costs 7

2.3.4 Relative-price variability and misallocation of resources 8

2.3.5 Inflation-induced tax distortion 8

2.4 Cost of unexpected inflation: Arbitrary redistributions of wealth 8

III Facts in Vietnam 9

1 Inflation in Vietnam in the 2016-2020 period 9

1.1 Inflation rate of Vietnam in the 2016-2019 period 9

1.2 Inflation rate of Vietnam in 2020 11

2 Nominal GDP, Money supply and Velocity of Money growth of Vietnam in 2016 – 2020 period 12

2.1 Vietnam’s Nominal GDP growth 12

2.2 Vietnam’s Money supply growth 13

2.3 Vietnam’s Velocity of money growth 14

3 The rationality of The Quantity Theory of Money in Vietnam 16

4 Factors affecting inflation in Vietnam in the future 17

4.1 Factors increase inflation pressure 17

4.2 Factors decrease inflation pressure 17

IV Conclusion 18

V References 19

I Introduction

Vietnam is considered a country with a stable macroeconomic foundation, which is an important driving force and factor for rapid and sustainable economic development The Economist magazine in August 2020 ranked Vietnam in the top 16 most successful emerging economies in the world.

According to economic theory, growth, inflation, balance of payments, unemployment are important macroeconomic factors that affect the macroeconomic balance of the economy, in which, the inflation factor is the top concern of any country After the fact that inflation in Vietnam soared to 18.13%, the highest since 2008 in 2011, our country had successful policies to curb inflation and maintain the low inflation rate at below 3,6% in the last 6 years, in the period from 2015 to 2016.

In the context that global inflation in 2021 is forecasted to increase quite strongly (maybe at 2.8% compared to 2% in 2020), inflation pressure in Vietnam has also begun to appear In the situation of economic instability because of the epidemic along with a large amount of money being injected into the economy but low capital efficiency, the state needs to take timely actions to control inflation in the future.

In this assignment, I will provide information about the inflation situation in Vietnam in the past and forecast in the future, and compare the inflation rate with changes in some other factors to evaluate the rationality of The Quantity Theory of Money when applied in Vietnam.

II Theory

1 Money Growth1.1 Demand for Money

Demand for money (MD) : the demand of money is based on the need for exchange, precaution and speculation Determinants of MD comprise of three factors :

MD = f(AE, i, P)

- The aggregate expenditure (AE): the sum of all the expenditures undertaken in the economy by the factors during a specific time period The aggregate expenditure determines the total amount that firms and households plan to spend on goods and services at each level of income.

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- Price level (P): the average of current prices across the entire spectrum of goods and services produced in an economy.

- Nominal interest rate (i): the interest rate announced by the bank, it reflects the increase in the amount of money when deposited in the bank

Although several factors influence money demand, one stands out as particularly important: the average level of prices in the economy Money is held by people because it serves as a medium of exchange People can use money to acquire the goods and services on their shopping lists, unlike other assets such as bonds or stocks The amount of money they keep for this purpose is determined by the prices of such items and services The higher the prices, the more money is required for a normal transaction, and the more money people opt to keep in their wallets and checking accounts That is, a greater price level (lower money value) raises the amount of money demanded.

1.2 Supply for Money

The money supply refers to the amount of cash or currency circulating in an economy This factor is under control of monetary policies and independent from the price.

Measures of money supply: the money supply is categorized by various monetary aggregates including M0, M1, and M2.

Coin money, physical paper, and central bank reserves make up the monetary basis, or M0 M1, the most often used aggregate, includes M0 as well as demand deposits and travelers' checks M2, on the other hand, includes M1 as well as savings deposits and money market shares, and may be used as a measure of inflation when compared to GDP.

The policies the central bank uses to change the money supply in the economy:

Open-Market Operation: The activity of a central bank buying or selling government

bonds in the market Through short-term trading of valuable papers, the central bank directly affects the available capital of credit institutions, thereby regulating the

money supply Central bank buy government bonds if they want to increase money supply and sell bonds if they want to reduce money supply.

Discount rate: The discount rate is the interest rate charged to commercial banks

and other financial institutions for short-term loans they take from the central bank When the central bank raise interest rates banks will deposit less money the money supply will increase.

Reserve Requirements: a central bank regulation of the cash-to-deposit ratio that

commercial banks are required to comply with to ensure liquidity When central bank reduce the reserve requirements, banks will loan more and the money supply will increase.

Paying Interest on Reserves: when a bank holds reserves on deposit at the central bank,

central bank now pays the bank interest on those deposits The less the interest rate on reserves, the less reserves banks will choose to hold and the money supply will increase.

1.3 Monetary Equilibrium

In the long run, money supply and money demand are brought into equilibrium by the overall level of prices If the price level is above the equilibrium level, people will want to hold more money than the Fed has created, so the price level must fall to balance supply and demand If the price level is below the equilibrium level, people will want to hold less money than the Fed has created, and the price level must rise to balance supply and demand At the equilibrium price level, the quantity of money that people want to hold exactly balances the quantity of money supplied by the Central Bank.

The two curves in this figure are the supply and demand curves for money The supply curve is vertical because the Fed has fixed the quantity of money available The

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demand curve for money slopes downward, indicating that when the value of money is low (and the price level is high), people demand a larger quantity of it to buy goods and services At the equilibrium, shown in the figure as point A, the quantity of money demanded balances the quantity of money supplied This equilibrium of money supply and money demand determines the value of money and the price level.

1.4 The Quantity Theory of Money

- P: Price level (GDP Deflator) - Y: The amount of output (real GDP) - MS: The quantity of money

- V: The velocity of money

So, P x Y is total value of goods/services (Nominal GDP) and MS x V is total payments needed.

Changes in price level:

%∆P + %∆Y = %∆MS + %∆V

Because the velocity of money is relatively stable over time, when the central bank

changes the quantity of money (M), it causes proportionate changes in the nominal value of output(P x Y) The economy’s output of goods and services (Y) is primarily determined

by factor supplies (labor, physical capital, human capital, and natural resources) and the available production technology In particular, because money is neutral, money does not affect output Therefore, when the central bank increases the money supply rapidly, the result is a high rate of inflation.

2 Inflation

2.1 Definition and Causes

In economics, inflation is defined as a gradual increase in the price of goods and services in a given economy When the general price level rises, each unit of currency buys less products and services; as a result, inflation equals a loss of money's purchasing power.

According to The Quantity Theory of Money, inflation is caused by a rise in the quantity of money, which can occur through a variety of causes in the economy The monetary authorities can increase the money supply by printing and giving out more money to individuals, legally devaluing (decreasing the value of) the legal tender currency, or more commonly (and most commonly) by lending new money into existence as reserve account credits through the banking system by purchasing government bonds from banks on the secondary market.

2.2 Inflation measurement

The Consumer Price Index (CPI), produced by the Bureau of Labor Statistics (BLS), is the most widely used measure of inflation The primary CPI (CPI-U) is designed to

measure price changes faced by urban consumers, who represent 93% of the U.S population It’s an average, though, and doesn’t reflect any particular consumer’s experience.

The method of calculating CPI in Vietnam has been applied since 1995 up to now in accordance with the guidance of the International Labor Organization (ILO), this is also the standard applied by most countries in the world and is now followed by the International Labor Organization (ILO) The latest ILO Consumer Price Index compilation guide issued in 2020 Therefore, the CPI calculation method of the General Statistics Office closely reflects the consumer price movement in the market and ensures comparability with those of the General Statistics Office data of countries in the world as well as in the region.

Calculation of inflation rate based on CPI Use the CPI to calculate the inflation rate, which is the percentage change in the price index from the preceding period That is, the inflation rate between two consecutive years is computed as follows:

Inflationrateinyear2=CPI in year 2−CPI in year 1 × 100%

CPI in year 1

2.3 Cost of expected inflation2.3.1 A fall in purchasing power

When the general price level rises, a unit of currency buys fewer goods and services than it used to, so inflation reflects a decrease in purchasing power per unit of currency.

If your wage stays the same but prices grow due to inflation, your purchasing power will dwindle, and you won't be able to buy as much as you could before.

2.3.2 Shoeleather Costs

When there is high inflation, the shoe leather cost is the cost of time and effort (or opportunity costs of time and effort) that people waste by holding less currency in order to lower the inflation tax they pay on cash holdings These expenses include making multiple bank trips, not being able to make change, and being unable to make unexpected expenditures The name stems from the fact that going to the bank and getting cash and spending it requires more walking (historically, though the introduction of the Internet has reduced this), thus wearing out shoes more quickly The extra time and convenience that must be sacrificed to keep less money is a substantial cost of lowering money holdings.

2.3.3 Menu Costs

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The expense incurred by a company as a result of adjusting its prices is known as menu cost The term comes from the expense of restaurants printing new menus, but economists apply it to the costs of altering nominal pricing in general Menu expenses, in this larger sense, might involve upgrading computer systems, re-tagging products, and paying consultants to devise new pricing methods, in addition to the actual costs of printing menus More broadly, the menu cost may be thought of as the sum of information, choice, and implementation costs, all of which result in restricted rationality Because of this cost, businesses do not always modify their pricing in response to changes in supply and demand, resulting in price stagnation.

2.3.4 Relative-price variability and misallocation of resources

Consumers compare the quality and costs of various items and services before deciding what to buy They make these judgments to decide how scarce production inputs are distributed among industries and enterprises When relative prices are skewed by inflation, consumer decisions are affected, and markets are less able to allocate resources efficiently Assume that the price of pork rises owing to inflation, and all the producers switch to producing more pork, causing the resources to be misallocated, causing the prices to rise.

2.3.5 Inflation-induced tax distortion

Almost all taxes distort incentives, affect people's behavior, and result in a less effective allocation of resources in the economy Many taxes, on the other hand, become considerably more burdensome when inflation is present The reason for this is that while creating tax legislation, legislators frequently neglect to account for inflation According to economists who have researched the tax code, inflation tends to increase the tax burden on saved income.

2.3.6 Confusion and inconvenience

It's impossible to estimate the price of inflation's uncertainty and inconvenient consequences We previously addressed how the tax law miscalculates actual incomes in the face of inflation Similarly, as prices rise over time, accountants miscalculate a company's earnings Because inflation causes the real worth of dollars to change over time, calculating a firm's profit—the gap between its income and costs—is more difficult in an inflationary environment.

2.4 Cost of unexpected inflation: Arbitrary redistributions of wealth

Unexpected inflation arbitrarily redistributes wealth from one group to another group, such as from borrowers to lenders When people decide to borrow money or lend money, they often consider what they think the rate of inflation will beWhen inflation differs from expectations, some groups may benefit, while others may suffer When

inflation exceeds expectations, lenders may suffer a loss, while borrowers may benefit Lenders win when inflation is lower than projected, while borrowers suffer.

III Facts in Vietnam

1 Inflation in Vietnam in the 2016-2020 period

Inflation rate of Vietnam in the 2016 - 2020 period (%)

There have been times when Vietnam's economy has been ravaged by high and persistent inflation, resulting in a catastrophic economic catastrophe (especially in the late 70s to early 90s) Inflation in Vietnam, on the other hand, has been steadily declining in recent years and has remained at a modest level The inflation rate in Vietnam has consistently been stable at below 4% and changed very little between 2016 and 2020, thanks to a harmonious balance of fiscal and monetary policies When it comes to inflation, Vietnam's rate is closely linked to the CPI, GDP growth rate, price changes within industries, and other factors that contribute to the macro-stability economy's and firmness The State Bank stated that it will maintain a careful and flexible monetary policy in the future, closely working with other macro measures in order to keep average inflation around 4%, as requested by the National Assembly.

1.1 Inflation rate of Vietnam in the 2016-2019 period

In 2016, CPI in December increased by 4.74% compared to December 2015, an average increase of 0.4% per month The average CPI in 2016 increased by 2.66% compared to the average of 2015 The increase in CPI in December 2016 compared to the same period in 2015 and the average increase in CPI in 2016 compared to the average in

9

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2015 increased higher than the previous year but much lower than the average CPI increase of some recent years, and still within the target limit of 5% set by the National Assembly Core inflation in December 2016 increased by 0.11% over the previous month and by 1.87% over the same period last year Average core inflation in 2016 increased by 1.83% compared to 2015.

In 2017, consumer price index (CPI) in December increased by 0.21% over the previous month; Average CPI in 2017 increased by 3.53% compared to 2016, below the target set by the National Assembly; CPI in December 2017 increased by 2.6% compared to December 2016, an average increase of 0.21% per month Core inflation in December 2017 increased by 0.11% over the previous month and by 1.29% over the same period last year Average core inflation in 2017 increased by 1.41% compared to 2016.

In 2018, the consumer price index (CPI) in December decreased by 0.25% compared to the previous month Average CPI in 2018 increased by 3.54% compared to 2017, below the target set by the National Assembly CPI in December 2018 increased by 2.98% compared to December 2017, an average increase of 0.25% per month Core inflation in December 2018 increased by 0.09% over the previous month and by 1.7% over the same period last year Average core inflation in 2018 increased by 1.48% compared to 2017.

In 2019, the consumer price index (CPI) in December increased by 1.4% compared to the previous month, this is the highest increase in the past 9 years, in which the group of food and food services increased by 3.42% due to the epidemic African swine fever causes a decrease in the supply of pork, and an increase in the price of products processed from pork, replacing pork The average CPI in 2019 increased by 2.79% compared to the average in 2018, below the target set by the National Assembly, this is also the lowest average annual increase in the past 3 years.

1.2 Inflation rate of Vietnam in 2020

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