The effect of money growth on inflation in vietnam from 2004 to 2010

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM- NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE EFFECTS OF MONEY GROWTH ON INFLATION IN VIETNAM FROM 2004 TO 2010 A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By BUI DINH PHUONG THAO Academic Supervisor: NGUYEN VAN NGAI CONTENTS CHAPTER 1: INTRODUCTION ! 1.1 PROBLEM STATEMENT 1.2 RESEARCH OBJECTIVES AND QUESTIONS 1.3 METHODOLOGY 1.4 STRUCTURE OF THESIS CHAPTER 2: LITERATURE REVIEW 2.1 THEORETICAL LITERATURE 2.1.1 INFLATION 2.1.2 SOURCES OF INFLATION Keynesian View Demand-pull inflation 11 Cost-push or structuralist inflation 13 Monetarists View 15 2.1.3 MONEY GROWTH 17 2.2 EMPIRICAL LITERATURE 21 2.3 AN OVERVIEW OF VIETNAM INFLATION AND MONEY GROWTH FROM 2000 TO 2010 29 2.3.1 INFLATION 29 2.3.2 MONEY GROWTH 31 2.4 CHAPTER REMARK 32 CHAPTER 3: RESEARCH METHODOLOGY, MODEL SPECIFICATION AND DATA SOURCES 34 3.1 ANALYTICAL FRAMEWORK 34 3.2 MODEL SPECIFICATION 35 3.3 DATA SOURCES 42 3.4 ECONOMETRICS TECHNIQUES 42 3.4.1 STATIONARITY AND UNIT-ROOT TEST .42 3.4.2 COINTEGRATION 44 3.4.3 ERROR CORRECTION MODEL (ECM) 47 3.4.4 SHORT-RUN CAUSALITY TESTS 49 Granger causality tests 49 Variance decomposition 51 Impulse response function 51 CHAPTER 4: THE EFFECTS OF MONEY GROWTH ON INFLATION IN VIETNAM FROM 2004 TO 2010 52 4.1 DESCRIPTIVE STATISTIC 51 4.2 ECONOMETRIC RESULTS , 54 4.2.1 UNIT ROOT TESTS , 54 4.2.2 BIVARIATE TESTS , 55 Engle-Granger cointegration tests 55 Error correction model 56 4.2.3 MULTIVARIATE TESTS 51 Johansen cointegration tests ., 57 Vector error correction model (VECM), Granger causality tests, variance decomposition and impulse response function 59 4.3 MODEL FORECASTS 66 4.4 RESULTS COMPARISON 66 4.5 CHAPTER REMARK 70 CHAPTER 5: CONCLUSIONS AND POLICY IMPLICATION 73 5.1 CONCLUSIONS 73 5.2 POLICY IMPLICATION 74 5.3 LIMITATION 76 REFERENCES APPENDIX LIST OF TABLES Table 3.1: Variables Description, Expected Signs and Data Sources 36 Table 4.1: Description of Variables 52 Table 4.2: Correlation among Variables 54 Table 4.3: Unit Root Tests Results 54 Table 4.4: Unit Root Tests for Residual ofCPI and M2 55 Table 4.5: Error Correction Model 56 Table 4.6: Johansen's Cointegration Tests With Lags 58 Table 4.7: Granger Causality Tests: P-Values For The lTests 60 Table 4.8: Variance Decomposition ofCPI (Order Reflects Cholesky Ordering) 62 Table 4.9: The Thesis' Results in Comparison with Empirical Studies' Results 67 • LIST OF FIGURES Figure 2.1: The Long-Run Macroeconomic Equilibrium Figure 2.2: Recessionary and Inflationary Gap 10 Figure 2.3: Government Intervention When Recessionary Gap Occurs 10 Figure 2.4: An Increase In Aggregate Demand 12 Figure 2.5: Demand-pull Inflation Spiral 13 Figure 2.6: An Increase in Short-run Aggregate Supply 14 Figure 2.7: A Cost-push Inflation Spiral 14 Figure 2.8: CPI in December and Average CPI from 2001 to 2010 31 Figure 2.9: Broad Money Growth From 2002 To 2010 32 Figure 3.1: Analytical Framework 34 Figure 4.1: Impulse Response Functions 65 CHAPTER 1: INTRODUCTION This chapter will explain the importance of this thesis, its objectives and research questions In addition, a brief of methodology is also mentioned in this part Finally, the structure of thesis will be presented l.lPROBLEM STATEMENT Money plays important role to the economy Greco (200 1) suggested money has five functions which are "a medium of exchange, a standard of value, a unit of account, a store of value and a standard of deferred payment" As a medium of exchange, money helps to divide the goods exchange process into two separate parts which are purchase process and sales process Therefore, people can buy goods at different places and sell goods in different time; hence money promotes trading activities Furthermore, money is used as standard to measure and present value of goods as well as prices of goods It extremely supports business to quote and record costs, products' prices and calculates value of gross domestic products (GDP), gross national products In addition, money is preferred to keep for future consumption and prevent risks As a standard of deferred payment, money makes payment become easier, more flexible and time-saving It increases the liquidity of debts, thus supports businesses and economic growth Based on its importance to the economy, money growth can affect the economy in many channels People receiving more money are willing to consume more, thus it stimulates consumption and encourages imports More money means more capital to make investment in order to expand companies' business Besides, growth in money supply will sponsor government's expenditure and decrease governmental budget deficit •positively Consequently, an increase in money stock may lead to growth in aggregate demand and affect the economy On the other hand, high growth in money may reduce its value and cause an increase in price level Monetarists suggested that money is the main determinant of inflation while Keynesian views argued money which leads aggregate • demand to exceed aggregate supply is only one of determinants of inflation However, Mishkin (1995) concluded that both monetarists and Keynesians believed that high inflation only possibly occurs with high money growth rate There are also a majority of empirical studies examining the effects of money growth on inflation Several studies suggested that money supply significantly positively influences inflation such as Moroney (2002), De Grauwe and Poland (2005), Thornton (2008), Kaufmann and Kugler (2008), Gingting and Bird (2009) and Basco, et al (2009) In contrast, some papers, for example Fie (2003), argued that the effects of money growth on inflation is insignificant In case of Vietnam, there are different findings regarding the dependence of inflation on money supply According to Baker, et al (2006), Goujon (2006) and Thanh (2008), money positively impacts price level On the other hand, a research of Hung and D Pfau (2008) pointed out this effect is unobvious In addition, according to the Vietnam's Prime Minister Nguyen Tan Dung (2011), the primary goals of the government at present are to stabilize macroeconomic and to control inflation at an appropriate level If money growth does affect inflation in Vietnam, monetary policy becomes a powerful policy for the government to maintain inflation at its target level However, there is few studies examined and quantified the effects of money growth on inflation in Vietnam in order to define the level of increases in money supply to meet the target inflation Therefore, this thesis aims to not only examine the influence of money growth on inflation but also estimate the level of money growth to achieve the expected inflation of the Vietnamese government in 2011 1.2 RESEARCH OBJECTIVES AND QUESTIONS Analyzing the impact of money • supply on inflation is extremely important for the government to conduct an appropriate monetary policy Therefore, this thesis aims to examine the effects of money growth on price level in long-run and short-run in Vietnam In order to meet this overall goal, the research will obtain following objectives: (i) Analyze the effects of money growth on inflation in Vietnam in long-run (ii) Analyze the effects of money growth on inflation in Vietnam in short-run (iii) Advise the level of money growth to meet the target inflation of the Vietnamese government in 20 11 The research questions are proposed: (i) Does money affect inflation in Vietnam in long-run? (ii) Does money affect inflation in Vietnam in short-run? (iii) Which level of money growth does meet the target inflation m 2011 of Vietnam's government? 1.3METHODOLOGY In order to examine the dependence of inflation on money growth in Vietnam in long-run and short-run, monthly data from December 2003 to June 2010 are collected from International Monetary Fund and Vietnam General Statistics Office The research will employ descriptive statistics and econometric techniques Descriptive analysis will firstly give a summary of all variables to provide an overview of data collection such as their distribution, central tendency and variation Then the correlation matrix will suggest the potential relationship between each pair of variables In addition, the unit root tests are used to test for stationary of all variables to ensure the validation oft-tests and F -tests After that, four econometric techniques will be applied in this thesis in order to examine the long-run and short-run effects of money growth on inflation Firstly, to investigate the long-run influence of money growth on inflation to answer the first research question, the Enge-Granger cointegration test and error correction mechanism (ECM) are employed Secondly, the thesis will add other determinants of inflation into a model with money growth then apply the Johansen co integration tests to re-test the effects of money growth on inflation in long-run and confirm the number of co integration equations After that, in order to answer the second research question, vector error correction model (VECM), Granger causality tests, variance decomposition and impulse response functions are used to examine the short-run impact of money on inflation Finally, a level of money growth is forecasted by applying VECM to meet the target inflation level of the Vietnamese government in 2011 to answer the third research question 1.4 STRUCTURE OF THESIS The thesis consists of five chapters Chapter presents the important of the thesis' findings and its objectives It also briefly presents the methodology is applied in the thesis Chapter demonstrates the literature review It starts with definitions of money growth and inflation Then the chapter focuses on Keynesian views and the quantity theory of money After that, empirical studies regarding the effects of money growth on inflation are introduced An overview of inflation rate and growth in money supply in Vietnam from 2000 to 2010 is also presented in this chapter Chapter is based on theories and empirical research to present an analytical framework then develop a model explaining inflation in short-run in Vietnam This chapter will mention data sources as well as economic techniques used in the thesis Chapter presents results of hypotheses testing and suggests the level of money growth to achieve the target inflation ofVietnamese government in 2011 Chapter will give the conclusion, policy implications and suggest for further studies APPENDIX 1: ENGLE-GRANGER COINTEGRATION TEST Augmented Dickey-Fuller test Null Hypothesis: RESIDCPI_M2 has a unit root Exogenous: None Lag Length: (Automatic based on SIC, MAXLAG=11) Augmented Dickey-Fuller test statistic Test critical values: *MacKinnon (1996) one-sided p-values Augmented Dickey-Fuller Test Equation Dependent Variable: D(RESIDCPI_M2) Method: Least Squares Date: 02/14/11 Sample (adjusted): 2004M04 2010M06 Included observations: 75 after adjustments Variable RESIDCPI_M2(-1) D(RESIDCPI_M2(-1)) D(AESIDCPI_M2(-2)) D(AESIDCPI_M2(-3)) 0.381357 0.129278 A-squared Adjusted A-squared S.E of regression Sum squared resid Log likelihood Durbin-Watson stat Phillips-Perron Null Hypothesis: AESIDCPI_M2 has a unit root Exogenous: None Bandwidth: (Newey-West using Bartlett kernel) Phillips-Perron test statistic Test critical values: *MacKinnon (1996) one-sided p-values Residual variance (no correction) HAC corrected variance (Bartlett kernel) Phillips-Perron Test Equation Dependent Variable: D(RESIDCPI_M2) Method: Least Squares Date: 02/14/11 Time: 20:30 Sample (adjusted): 2004M01 201 OM06 Included observations: 78 after adjustments Variable RESIDCPI_M2(-1) A-squared Adjusted A-squared S.E of regression Sum squared resid Log likelihood Durbin-Watson stat APPENDIX 2: ERROR CORRECTION MODEL Dependent Variable: D(CPI) Method: Least Squares Date: 04/08/11 Time: 23:06 Sample (adjusted): 2004M01 2010M06 Included observations: 78 after adjustments Variable c D(M2) AESIDCPI_M2 A-squared Adjusted A-squared S.E of regression Sum squared resid Log likelihood F-statistic Prob(F-statistic) APPENDIX 3: JOHANSEN'S COINTFGRATION TESTS Date: 02/14/11 Time: 20:34 Sample (adjusted): 2004M10 2010M06 Included observations: 69 after adjustments Trend assumption: Linear deterministic trend Series: CPI M2 OUTPUT CREDIT RATE FOREX Lags interval (in first differences): to ' Unrestricted Cointegration Rank Test (Trace) Hypothesized No of CE(s) None* At most * At most * At most * At most * At most Trace test indicates cointegrating eqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **MacKinnon-HaugMichelis (1999) p-values Unrestricted Cointegration Rank Test (Maximum Eigenvalue) Hyp No At At At At A Max-eigenvalue test indicates cointegrating eqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **MacKinnon-HaugMichelis (1999) p-values Unrestricted Cointegrating Coefficients (normalized by b'*S11*b=l): CPI 154.0283 26.52877 414.9928 358.5410 -136.7728 -347.7573 D(CPI) D(M2) D(OUTPUT) D(CREDIT) D(RATE) D(FOREX) Cointegrating Equation(s): Log likelihood 1900.163 Normalized cointegrating coefficients (standard error in parentheses) CPI 1.000000 Adjustment coefficients (standard error in parentheses) D(CPI) D(M2) D(OUTPUT) D(CREDIT) D(RATE) D(FOREX) 0.045776 (0.04404) -0.079094 (0.14432) -2.079643 (1.38822) -0.248630 (0.14301) -0.700629 (0.41533) -0.076829 (0.05958) Cointegrating Equation(s): Normalized cointegrating coefficients (standard error in parentheses) CPI 1.000000 0.000000 Adjustment coefficients (standard error in parentheses) D(CPI) D(M2) D(OUTPUT) D(CREDIT) D(RATE) D(FOREX) Cointegrating Equation(s): Normalized cointegrating coefficients (standard error in parentheses) CPI 1.000000 0.000000 0.000000 Adjustment coefficients (standard error in parentheses) FOREX 20.99227 (4.74099) -7.236138 (3.88707) -47.73454 (11.0818) D(CPI) D(M2) D(OUTPUT) D(CREDIT) D(RATE) D(FOREX) Cointegrating Equation(s): Normalized cointegrating coefficients (standard error in parentheses) CPI 1.000000 0.000000 0.000000 0.000000 Adjustment coefficients (standard error in parentheses) D(CPI) D(M2) D(OUTPUT) D(CREDIT) D(RATE) D(FOREX) Cointegrating Equation(s): Normalized cointegrating coefficients (standard error in parentheses) CPI 1.000000 0.000000 0.000000 0.0000 0.000000 0.0000 0.000000 0.0000 D(CPI) D(M2) D(OUTPUT) D(CREDIT) D(RATE) D(FOREX) APPENDIX 4: VECTOR ERROR CORRECTION MODEL Vector Error Correction Estimates Date: 01/07/11 Time: 23:19 Sample (adjusted): 2004M10 2010M06 Included observations: 69 after adjustments Standard errors in () & t-statistics in [] Cointegrating Eq: CPI(-1) M2(-1) OUTPUT(-1) CREDIT(-1) RATE(-1) FOREX(-1) c Error Correction: CointEq1 CointEq2 CointEq3 D ~ D D D D D D(O ~ D(O D(O D(O D(O • D(O ~ D(O D(O D(O • D(C D(C D(C D(C D(C D(C D(C D(C D(C D( D( D( D(RATE(-4)) D(RATE(-5)) D(RATE(-6)) D(RATE(-7)) D(RATE(-8)) D(RATE(-9)) D(FOREX(-1)) D(FOREX(-2)) D(FOREX(-3)) D(FOREX(-4)) D(FOREX(-5)) D(FOREX(-6)) D(FOREX(-7)) D(FOREX(-8)) D(FOAEX(-9)) c A-squared Adj A-squared Sum sq resids S.E equation F-statistic Log likelihood Akaike AIC Schwarz SC Mean dependent S.D dependent Determinant resid covariance (dof adj.) Determinant resid covariance Log likelihood Akaike information criterion I Schwarz criterion • APPENDIX 5: GRANGER CAUSALITY TESTS VEC Granger Causality/Block Exogeneity Wald Tests Date: 02/14/11 Time: 20:50 Sample: 2003M12 2010M06 Included observations: 69 Dependent variable: D(CPI) i ~ • ( I i ~ D(CREDIT) D(RATE) All Dependent variable: D(OUTPUT) Dependent variable: D(CREDIT) Dependent variable: D(RATE) Dependent variable: D(FOREX) ... money growth on inflation in Vietnam in order to define the level of increases in money supply to meet the target inflation Therefore, this thesis aims to not only examine the influence of money growth. .. suggested to stronger influences inflation in 32 high -inflation countries than it is in low -inflation countries in long-run In contrast, the contribution of money growth in explaining inflation is... short-run effects of money growth on inflation as well as the importance of money supply in explaining inflation in Vietnam 3.2 MODEL SPECIFICATION In order to examine the short-run effects of money growth