Econometrics report factors affecting inflation rate

FOREIGN TRADE UNIVERSITY FACULTY OF INTERNATIONAL ECONOMICS -*** - ECONOMETRICS REPORT FACTORS AFFECTING INFLATION RATE Instructor : PhD Đinh Thị Thanh Bình Group : 07 Course : KTE309E(GD1-HK1-2223)CTTT.1 Ha Noi, October 2022 GROUP MEMBERS Name STT Student ID Contribution (%) Nguyen Quoc Viet 88 2011140219 25% Doan Vu Nhat Mai 46 2011140210 25% Pham Kim Hoa 24 2011140204 25% Nguyen Phuong Thao 74 2011140217 25% ABSTRACT Under the study of econometric models, the article investigates the effect of the unemployment rate, GDP growth rate, local exchange rate, and production price index (PPI) as factors impacting a country’s inflation When prices for energy, food, commodities, and other products and services rise during this time, the entire economy suffers Inflation affects the cost of living, the cost of conducting business, borrowing money, mortgages, corporate and government bond rates, and all other aspects of the economy The researcher used data collected on each variable from different nations to operationalize the volatility in the inflation rate This study, which incorporates data from estimated models, regression analysis, and diagnosing and addressing problems on the platform of STATA software, indicates that all four factors have a positive correlation with the inflation rate However, the finding also reveals that the unemployment rate is incompatible with economic theory Keywords: Inflation rate, regression model, coefficient TABLE OF CONTENT CHAPTER 1: INTRODUCTION CHAPTER 2: LITERATURE REVIEW Inflation Factors affecting inflation rate 2.1 Unemployment rate 2.2 GDP Growth rate 2.3 Local exchange rate 2.4 Production Price Index (PPI) Research overview 3.1 Published relevant studies 3.2 Research gap 8 9 10 10 12 CHAPTER 3: RESEARCH METHODOLOGY AND ECONOMETRICS MODEL Research hypothesis Establish theoretical model 2.1 Methods of data collection and processing 2.2 Model of theory 2.3 Data description 2.4 Describe the correlation between the variables CHAPTER 4: QUANTITIES TESTS 14 14 14 14 15 15 18 20 Estimated model 1.1 OLS testing result 1.2 Sample Regression Function 1.3 Describe and explain the variables used in the regression model Diagnosing and solving problems of the model 2.1 Ramsey RESET Test 2.2 Multi-collinearity Test 2.3 Heteroskedasticity Test 2.4 Testing the normality of residual u The results of estimators after solving problems Testing hypothesis of postulated model 4.1 Testing statistical significance of regression coefficients 4.2 Testing overall significance of the model 4.3 Testing the significance of the model with economics theories Result explanation 5.1 Meaning of estimators of regression coefficients 20 20 20 21 21 21 22 23 26 26 27 27 28 28 30 30 5.2 Determination coefficient (R-squared) 5.3 Result analysis 31 32 CHAPTER 5: CONCLUSION 35 REFERENCES 36 CHAPTER 1: INTRODUCTION In terms of economics, inflation is defined as a rise in the general level of prices of goods and services in an economy over a period of time When the price level increases, each unit of currency buys fewer goods and services In other words, it can be said that inflation is a sustained rise in the general price level The general price level is a value that reflects the overall price level for goods and services in an economy at a particular time A country's economic development as well as the nation itself may be negatively impacted by inflation in numerous ways A high inflation rate will increase the living cost and the living standards of people in a particular country One of the most significant macroeconomic variables, and one that economic factors, including the government, fear the most since it can have a negative impact on the distribution of income and the structure of production costs, is inflation Additionally, broader repercussions like instability, economic expansion, deteriorating competitiveness, interest rates, unequal income distribution, and unemployment are getting worse Some of the nations that have experienced hyperinflation have demonstrated that low inflation does not promote economic growth but rather social and political unrest It may be claimed that over the past few years, literally every nation on earth has experienced inflation There are numerous elements that can be employed to explain this global phenomenon Either external or economic causes are at blame for this issue This research paper will be organized as follows: ● Chapter 1: Introduction ● Chapter 2: Literature review ● Chapter 3: Research methodology and Econometrics model ● Chapter 4: Quantities tests ● Chapter 5: Conclusion Although all the data and information are gathered as well as analyzed carefully, there are still some mistakes in the report due to a lack of practical knowledge Our team is looking forward to receiving feedback from Ms Dinh Thi Thanh Binh so that we could complete the research thoroughly   Also, we would like to thank Ms Dinh Thi Thanh Binh for the meticulous instruction during the course We appreciate everything you have taught us, and we promise to put out our best effort in this report and on the final exam CHAPTER 2: LITERATURE REVIEW Inflation The overall increase in goods prices over the past few decades has been the primary issue facing the global economy There were major distortions in the monetary, economic, political, and social environments as a result of the pressure brought on by rising prices Inflation is defined as an increase in prices accompanied by a decrease in the value of money Hamilton (2001) said that inflation has been described as an economic situation when the increase in the money supply is "faster" than the new production of goods and services in the same economy Because it has the potential to negatively impact the structure of production costs and the level of welfare, inflation is one of the most significant macroeconomic variables and the one that economic actors, including the government, fear the most Inflation consists of, first, inflation due to a lack of goods (natural inflation) and second, inflation because of human error caused by corruption and poor administration, excessive tax policies which implicates burden of farmers and amount of excessive money Inflation can be caused by excess/pull request (liquidity/money/currency) occurs due to excessive total demand which is usually triggered by a flood of liquidity in the market resulting in a high demand and trigger changes in the price level Increasing the volume of the medium of exchange or liquidity associated with the demand for goods and services resulting in increased demand for factors of production The increasing demand for production factors causing prices to rise While inflation insistence costs (cost push inflation) occurs due to the scarcity of production and/or also include the scarcity of distribution The lack of launch of distribution flow or the reduction of production provided from the average normal demand could trigger a price increase in accordance with the legal validity of the demand - supply Inflation is the main factor of economic crisis, discourages investments and determines the migration of capital to other countries or real estates The broken equilibrium created by inflation strongly affects the decisions of the private sector to invest or develop, with the final effects in decreasing production and stagnation The wider effects such as instability, economic growth, the declining competitiveness, the interest rate, uneven income distribution and unemployment are increasing Some of the countries that have experienced hyperinflation showed that poor inflation would lead to social and political instability, and did not create economic growth Factors affecting inflation rate The determinants of inflation are very much important in building economic forecasts in planning models and in several sectors although the factors change from country to country instead of some general variables Even the relationship changes from one period to another which was found in many econometric studies Those factors are very diverse and action into the national economy and from external sources From the large number of known inflation influence factors, we tried to endeavor to locate some determinants of inflation in some countries such as Unemployment rate, GDP growth rate, Local exchange rate, and Producer Price Index 2.1 Unemployment rate When there is a greater demand for labor than there are available positions, economists refer to this scenario as unemployment The relationship between unemployment and inflation has historically been inverse One causes the other to fall when it rises and vice versa To prevent overstimulating or excessive slowdown of the economy, governments often rely on monetary and fiscal policy It makes sense that these two things are connected When unemployment is low, there are more jobs needed than there are workers to fill them Simply said, there are more open positions than there are open positions On the other side, when unemployment increases, there are far more job seekers than there are open positions This is so even while more people wish to find employment, few firms are really employing 2.2 GDP Growth rate Gross domestic product (GDP) is the total monetary or market value of all the finished goods and services produced within a country’s borders in a specific time period As a broad measure of overall domestic production, it functions as a comprehensive scorecard of a given country’s economic health The calculation of a country’s GDP encompasses all private and public consumption, government outlays, investments, additions to private inventories, paid-in construction costs, and the foreign balance of trade (Exports are added to the value and imports are subtracted) GDP Growth Rate is also known as the Economic Growth Rate, and it measures the change in the GDP of the country in comparison to an earlier period The amount of change is measured in percentage (%), which serves as a determinant of economic health in the country and the possible growth in the future The GDP of a certain period, when set against another, can show a comparison that can be measured using the given formula: Economic Growth = (GDP2 - GDP1) / GDP1 The result is expressed in a percentage If the result is positive, it means the economy is growing by the said percent If the growth rate is percent from the previous quarter to now, it means that the economic activity has risen by 2%, either due to increased Government expenditure, higher retail consumption or in exports and imports 2.3 Local exchange rate An exchange rate is a rate at which one currency will be exchanged for another currency and affects trade and the movement of money between countries Exchange rates are impacted by both the domestic currency value and the foreign currency value The exchange rate between two currencies is commonly determined by the economic activity, market interest rates, gross domestic product, and unemployment rate in each of the countries Commonly called market exchange rates, they are set in the global financial marketplace, where banks and other financial institutions trade currencies around the clock based on these factors Changes in rates can occur hourly or daily with small changes or in large incremental shifts Exchange rates can be free-floating or fixed A free-floating exchange rate rises and falls due to changes in the foreign exchange market A fixed exchange rate is pegged to the value of another currency 2.4 Production Price Index (PPI) The producer price index (PPI) measures the average change over time in the prices domestic producers receive for their output It is a measure of inflation at the wholesale level that is compiled from thousands of indexes measuring producer prices by industry and product category The PPI measures inflation (or, much less commonly, deflation) from the perspective of the product manufacturer or service supplier The price trends for producers and consumers are unlikely to diverge for long since producer prices heavily influence those charged to consumers From the above result, we can refer that: - VIF (lnlexchrate) = 1.18 < 10 - VIF (lnurate) = 1.14 < 10 - VIF (lngdpgrr) = 1.08 < 10 - VIF (lnppi) = 1.01 < 10 Because the VIF of the variables and Mean VIF are smaller than 10 => Hypothesis 𝐻0 is accepted Conclusion: The model does not exist multicollinearity at a significant level of 5% 2.3 Heteroskedasticity Test Set up hypothesis 𝐻0, 𝐻1: - 𝐻0: The model has homoskedasticity - 𝐻1: The model has heteroskedasticity In STATA, by using imtest, white , we have the result: 23 Table 5.1 - As P-value = 0.0000 is lower than 5%, hence, at a significant level of 5%, we reject hypothesis 𝐻0 and accept hypothesis 𝐻1 => The model has heteroskedasticity at a significant level of 5% To have a more accurate result, we also use hettest in STATA and have the result: - As P-value = 0.2141 is greater than 5%, hence, at a significant level of 5%, we accept hypothesis 𝐻0 and reject hypothesis 𝐻1 => The model does not have heteroskedasticity at a significant level of 5% 24 Conclusion: By using two different tests (White test and Breusch- Pagan test), we have different results However, we have to use White test as it has heteroskedasticity at a significant level of 5% Consequence: When the model has heteroscedasticity, the estimators are still linear and unbiased, but not the best The variance of the coefficient will be biased, making the standard error (se) biased, resulting in the inaccuracy of the hypothesis test Solution: Using Robust Standard Error Method In STATA, by using reg lninflarate lngdpgrr lnlexchrate lnurate lnppi, robust, we have the result: Table From the above result, we can refer that: After using Robust Standard Error Method, coefficients of given variables and R-squared = 0.2140 remain unchanged There is only a change in standard error which leads to the change in 25 t, P-value and confidence interval Therefore, we have to use the new value of t, P-value and confidence interval from the above table to the test regression coefficient 2.4 Testing the normality of residual u Set up hypothesis 𝐻0, 𝐻1: - 𝐻0: Residuals u has normal distribution - 𝐻1: Residuals u does not have normal distribution In STATA, by using predict u, residuals and sktest u, we have the result: Table - As P-value = 0.4932 > 5% => At a significant level of 5%, we can not reject hypothesis 𝐻0 Conclusion: Residuals u of the model have normal distribution at significant level of 5% The results of estimators after solving problems After testing and fixing the problems of heteroscedasticity, the group decides to keep the regression function as initial: lninflarate = -3.350463 + 0.1870049lngdpgrr + 0.0584007lnlexchrate + 0.4246856lnurate + 0.6955721lnppi + 𝑢𝑖 26 However, our group is going to use the new values of t, P-value and interval confidence in Table to the hypothesis test of the model in Table 4 Testing hypothesis of postulated model 4.1 Testing statistical significance of regression coefficients Set up hypothesis 𝐻0, 𝐻1: - 𝐻0: Regression coefficients of independent variables not have statistical significance (βj=0) - 𝐻1: Regression coefficients of independent variables have statistical significance (βj≠0) Based on the result of postulated model, we have - Constant coefficients: P-value ≈ 0.108 > 0.05 → Do not reject 𝐻0 Therefore, regression coefficients of constant coefficients not have statistically significant effects on lninflarate at the 0.05 level - Variable lngdpgrr: P-value ≈ 0.016 < 0.05 → Reject 𝐻0 Therefore, regression coefficients of variable lngdpgrr have statistically significant effects on lninflarate at the 0.05 level - Variable lnlexchrate: P-value ≈ 0.005 < 0.05 → Reject 𝐻0 Therefore, regression coefficients of variable lnlexchrate have statistically significant effects on lninflarate at the 0.05 level - Variable lnurate: P-value ≈ 0.000 < 0.05 → Reject 𝐻0 Therefore, regression coefficients of variable lnurate have statistically significant effects on lninflarate at the 0.05 level 27 - Variable lnppi: P-value ≈ 0.118 > 0.05 → Do not reject 𝐻0 Therefore, regression coefficients of variable lnppi not have statistically significant effects on lninflarate at the 0.05 level Conclusion: After using the P-value testing method to examine statistical significance of regression coefficients, we can confirm that regression coefficients of independent variables, except PPI, have statistically significant effects on Inflation rate at the 0.05 level 4.2 Testing overall significance of the model Set up hypothesis 𝐻0, 𝐻1: - 𝐻0: β1 = β2 = β3 = (All independent variables not explain for any value of dependent variables) 2 - 𝐻1: β1 + β2 + β3 ≠ - 𝐻0: 𝑅 = - 𝐻1: 𝑅 ≠ Or: 2 Based on the postulated result of the model, we have Fs= 11.81 > 𝐹5%(4; 149) = 2.43 → Reject 𝐻0 Conclusion: At a significant level of 5%, the model has overall significance 4.3 Testing the significance of the model with economics theories a With lngdpgrr Set up hypothesis 𝐻0, 𝐻1: 28 - 𝐻0: β1 = - 𝐻1: β1 > We have 𝑡α = 𝑡0.05149 ≈1 976 Because |ts|= 2.45 > 𝑡α = 976 → Reject 𝐻0 Conclusion: At the significant level of 5%, ceteris paribus, the regression coefficient of lngdpgrr is positive, it is suitable with the economic theory that inflation rate will increase when the GDP growth rate increases b With lnlexchrate Set up hypothesis 𝐻0, 𝐻1: - 𝐻0: β2 = - 𝐻1: β2 > We have 𝑡α = 𝑡0.05149 ≈1 976 Because |ts| = 2.83 > 𝑡α = 976 → Reject 𝐻0 Conclusion: At the significant level of 5%, ceteris paribus, the regression coefficient of lnlexchrate is positive, it is suitable with the economic theory that inflation rate will increase when foreign exchange rate increases c With lnurate Set up hypothesis 𝐻0, 𝐻1: - 𝐻0: β3 = 29 - 𝐻1: β3 > We have 𝑡α = 𝑡0.05149 ≈1 976 Because |ts| = 5.24 < 𝑡α = 976 → Reject 𝐻0 Conclusion: At the significant level of 5%, ceteris paribus, the regression coefficient of lnlexchrate is positive, it is unsuitable with the economic theory that inflation rate will drop when Unemployment rate increases d With lnppi Set up hypothesis 𝐻0, 𝐻1: - 𝐻0: β3 = - 𝐻1: β3 > We have 𝑡α = 𝑡0.05149 ≈1 976 Because |ts| = 1.57 < 𝑡α = 976 → Cannot reject 𝐻0 Conclusion: At the significant level of 5%, PPI has no statistically significant effect on inflation rate Result explanation 5.1 Meaning of estimators of regression coefficients β0= -3.350463 (Estimation for constant coefficient): When all independent variables equal 0, the expected value of the inflation rate will be -3.350463% 30 β1= 0.1870049 (Estimation for the regression coefficient of GDP growth rate): When all independent variables remain unchanged, the expected value of the GDP growth rate will increase by 0.1870049 % if inflation rate increases by unit β2= 0.0584007 (Estimation for the regression coefficient of local exchange rate): When all independent variables remain unchanged, the expected value of local exchange rate will increase by 0.4246856 % if inflation rate increases by unit β3= 0.4246856 (Estimation for the regression coefficient of unemployment rate): When all independent variables remain unchanged, the expected value of unemployment rate will increase by 0.4246856 % if inflation rate increases by unit β4= 0.695721 (Estimation for the regression coefficient of producer price index): When all independent variables remain unchanged, the expected value of producer price index will increase by 0.695721% if inflation rate increases by unit 5.2 Determination coefficient (R-squared) Determination coefficient 𝑅 = 0.2140 means that the independent variables (GDP growth rate, Local exchange rate, Unemployment rate, Producer price index) can explain 21.40% of the sample variation of inflation rate Besides, we also consider adjusted 𝑅 , as when adding new variables in the model, 2 despite its significance, 𝑅 increases The increase of 𝑅 will increase the explanatory power of the model but cannot clarify the importance of the input variable, resulting in the incorrectness of the model Therefore, adjusted 𝑅 is used to determine the variables Adjusted 𝑅 is calculated as following: 𝑅 = 1− 𝐸𝑆𝑆 𝑛−𝑘−1 𝑇𝑆𝑆 (𝑛−1 =1 − 31 𝑛−1 𝑛−𝑘−1 (1 − 𝑅 ) In which: n: number of observation k: number of independent variable 𝑅 : determination coefficient From the above formula, we can calculate 𝑅 = 0.1929 That means independent variables can explain 19.29% the sample variation of dependent variable, the remaining 80.71% is explained by variables outside the model 5.3 Result analysis According to our researching result, we can conclude that: ● As GDP growth rate increases, inflation rate increases and vice versa, ceteris paribus ● As local exchange rate increases, inflation rate increases, and vice versa, ceteris paribus ● As the unemployment rate increases, inflation rate increases and vice versa, ceteris paribus ● As the producer price index increases, inflation rate increases and vice versa, ceteris paribus Meanwhile, the postulated estimation results indicate that: ● Regression coefficient estimator of lngdpgrr is β1= 0.1870049 ● Regression coefficient estimator of lnlexchrate is β2= 0.0584007 ● Regression coefficient estimator of lnurate is β3= 0.4246856 ● Regression coefficient estimator of lnppi is β4= 0.695721 32 Therefore, all regression model results, except for unemployment rate, are consistent with economic theories Concerning GDP growth, it's clear inflation and GDP growth go hand-in-hand (Hall, 2021): ● Scenario 1: To satisfy rising demand, production is being boosted Higher output leads to a reduced unemployment rate, which fuels demand even more Wage increases contribute to increased demand as people spend more freely This results in greater GDP and inflation ● Scenario 2: There is no rise in customer demand, yet prices are greater In this scenario, both GDP and inflation rise These rises are the result of decreased supply of critical commodities and rising consumer expectations, rather than increased demand ● Scenario 3: There is both growing demand and a supply shortfall Businesses must recruit more workers, creating demand by raising pay Increased demand in the face of limited supply swiftly drives up costs In this scenario, GDP and inflation both rise at unsustainable rates that policymakers find impossible to influence or control ● Scenario 4: This is quite similar to what occurred in the United States in the 1970s and is commonly referred to as stagflation GDP grows slowly and at a lower rate than expected, yet inflation continues and unemployment stays high due to poor output Concerning local exchange rate, the exchange rate affects the rate of inflation and economic growth When the exchange rate increases, the price of imported goods becomes more expensive, increasing the rate of inflation Conversely, a falling exchange rate means an increase in the local currency, cheaper imported goods, and moderate inflation Concerning the unemployment rate, we state that it does not align with any economic theory However, we can possibly say that it is due to the fact that our sample is derived from countries that are highly developed, thus low unemployment rate and the following scenario can happen: When employment is at or near its lowest point Extremely low unemployment rates 33 have shown to be more costly than helpful since a near-full employment economy causes two crucial things to happen (Barnes, 2021): Prices will rise when aggregate demand for goods and services rises faster than supply As a result of the tight labor market, businesses will have to hike salaries As the corporation seeks to maximize profits, this increase is frequently passed on to customers in the form of increased pricing This, over time, causes the growth in GDP, resulting in a rise in inflation, as previously analyzed in the first place If inflation is not controlled, it has the potential to become hyperinflation Once in place, this process may soon create a self-perpetuating feedback loop This is because, in an inflationary environment, individuals will spend more money because they expect it to be less valuable in the future This promotes more short-term rises in GDP, resulting in further price increases Concerning producer price index, we may claim that the PPI and the inflation rate are statistically significant, but we cannot assume that if the PPI rises, the inflation rate would rise as well The producer price index (PPI) does, in fact, evaluate inflation from the standpoint of costs to industry or product manufacturers 34 CHAPTER 5: CONCLUSION Generally, inflation is caused by the fall in aggregate supply to equal the increase in aggregate demand It can be controlled by increasing the supplies of goods and services and reducing money incomes in order to control aggregate demand High inflation may cause a negative impact on a particular country This research paper discussed and analyzed four factors which are the GDP growth rate, foreign exchange rate, Unemployment rate, and PPI by utilizing the regression model We collected the dataset of those factors indicators on credible websites We used annual data for the period from 2010 to 2021 to know the exact impact of those factors to the price level The results show that while the relationships between GDP growth rate, foreign exchange rate, unemployment rate and inflation are positive, PPI has no statistically significant effect on the inflation rate In addition, it can be seen as there are more factors that can be affecting inflation as the R-square value is insignificant It means that the three factors that have been discussed in this research, are just a part of the factors that influence inflation throughout the world These findings indicate that inflation is a disease in the economy of a country that brings impacts to all economic activities Another number of research results stated that the variables 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