INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM VIETNAM- NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE IMPACTS OF MONETARY POLICY ON OUTPUT GROWTH AND INFLATION IN VIETNAM: A VAR APPROACH A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By VO PHUOC THUAN Academic Supervisor: Assoc Prof Dr NGUYEN TRONG HOAI and Dr PHAM KHANH NAM HO CHI MINH CITY, JANUARY 2013 ACKNOWLEDGEMENT First of all, I would like to convey sincere thanks to my supervisors Assoc Prof Dr Nguyen Trong Hoai for his guidance, support and patience ensuring a successful completion of the thesis I wish to thank my co-supervisor Dr Pham Khanh Nam for his encouragement and willingly supports during the thesis writing process with the valuable comments and suggestions I wish to thank all staffs and my fellow classmates at the Vietnam-Netherlands Programme for M.A in Development Economics for the devoted support and positive interaction throughout the years I also wish to show my thankfulness to Mr Hoang Quang Hung for his devoted help and support in the process of the thesis I also wish to show my thankfulness to the Vietnam-Netherlands Programme for M.A in Development Economics along with all professors at there which have provided me the knowledge and opportunity to access the best conditions for my study What I have learned from their lectures not only help me get knowledge for doing the thesis but also provide me more profound understanding on economics particularly and life generally To my family, no word can express all my love to them They have always been my biggest encouragement I could not have finished this course without them Thank you, mom and my wife, who always encourage and try their best to give me the best condition so that I can complete the thesis CERTIFICATION I declare that the Thesis, which I hereby submit for the degree of Master of Arts in Development Economics at the Vietnam -Netherlands Programme For M.A In Development Economics - University of Economics Ho Chi Minh City - Vietnam, is the result of my own work with the guidance of the supervisors, except where otherwise stated Other sources are acknowledged by explicit references I certify that the material contained in this thesis has not been submitted in support of an application for another degree or qualification in this or any university VO PHUOC THUAN Date: January 21, 2013 ABSTRACT Understanding of monetary policy and the way it is transmitted to the economy through different channels and the time it needs to take effect are both important, which are "visible hand" that could help the country to get over the challenges to achieve the target This thesis examines the impact of monetary policy on real output growth and inflation of the urban area, rural area and all over of Vietnam by using the vector auto-regression (VAR) focusing on the reduced-form relationships between money supply, real output growth, price level (of the urban area, rural area and all over of Vietnam), interest rate (lending rate), credit and exchange rate The result suggests that money supply have impact on real output growth and inflation in the urban area, the rural area and all over of Vietnam but the impacts are at low percentage The fact that the thesis cannot find out any channel having the impact on the real output growth, this suggest that monetary policy may take impact on real output growth through other channels which are not mentioned in this thesis Among the three mentioned channels there is only credit channel has the impact on the inflation An increase in domestic credit has the positive effects on inflation This suggests the need of a system of policies that manage the credit channel in the right way to control inflation rates efficiently Interest rate channel has been found to be a very important channel of monetary transmission mechanism in other countries but it is not significant in Vietnam This means that interest rate policy has not been implemented in an effective way There is also destitute evidence of the response of real output growth and inflations to changes in exchange rate This means that exchange rate does not seem to be an important channel of monetary policy as well TABLE OF CONTENT CHAPTER 1: INTRODUCTION ! 1.1 Problem Statement 1.2 Significant of the study 1.3 Research objectives 1.4 Research questions 1.5 Thesis Structure CHAPTER II: LITERATURE REVIEW 2.1 Theoretical literature review 2.1.1 Mechanism of the impact of aggregate demand to output and price level 2.1.2 Traditional Keynesian IS/LM model 2.1.3 The Mundell-Fleming model 2.1.4 Tobin q 's theory 2.1.5 Monetary transmission mechanism + The interest rate channel + The credit channel 10 + The exchange rate channel 13 2.1.6 Conceptual framework for the study 15 2.2 Previous empirical studies related 16 2.3 Chapter remarks 23 CHAPTER III: ECONOMY PERFORMANCE, FINANCIAL SYSTEM AND MONETARY POLICY TOOLS IN VIETNAM 24 3.1 Economy performance 24 1.1 Economic growth 24 3.1.2 Inflation and output growth 25 3.2 Finacial system and the role of Central Bank in Vietnam 26 3.3 Monetary policy .29 3.3.1 Legal framework 29 3.3.2 Monetary policy tools 30 • • 3.4 Chapter remarks 33 CHAPTER IV: RESEARCH METHODOLOGY 34 4.1 Model specification 34 4.2 Data availability and description 35 4.2.1 Data availability 35 4.2.2 Data description 36 4.2.3 Descriptive analysis of data 40 4.3 Test for stationary property" 40 4.4 Model estimation and regression result .41 4.4.1 Model estimation 41 4.4.2 Regression result 43 a) Basic model 43 b) Extended model with lending rate 47 c) Extended model with domestic credit 49 d) Extended model with exchange rate 51 4.4.3 Chapter remarks 51 CHAPTER V: CONCLUSION, POLICY IMPLICATION, LIMITATION, AND SUGGESTION FOR FURTHER RESEARCHES 53 5.1 Conclusion 53 5.2 Policy implication 55 5.3 Limitation of the study 56 5.4 Suggestion for further researches 56 References 58 LIST OF ACRONYMS AND ABBREVIATIONS DF test: Dicky Fuller test E or ER: Exchange rate ECB: European Central Bank VD: Variance Decomposition FED: The Federal Reserve System is the central bank of the United States GDP: Gross Domestic Product GSO: General Statistic Office 1: Interest rate 1: Investment ICOR: Incremental Capital-Output Ratio DOT: Direction of Trade Statistics IFS: International Finance Statistics IMF: International Monetary Fund OECD.Stat: Organisation for Economic Co-operation and Development StatExtracts AD-AS model: Aggregate Demand-Aggregate Supply model ISILM model: Investment-Saving I Liquidity preference-Money supply model Ms orMS: Money supply M2: Broad money or high-powered money NEER: Nominal Effective Exchange Rate REER: Real Effective Exchange Rate NX: Net export OIRF or IRF: Orthogonalized Impulse Response Function P or CPI: Consumer Price Index pe: Expected Price Level Pe: Equity price • 1te : Expected inflation SBV: State Bank of Vietnam u.s The United States of America VAR: Vector Auto-Regression Y: Output LR: likelihood ratio test FPE: Final prediction error AIC: Akaike information criterion SC: Schwarz information criterion HQ: Hannan-Quinn information criterion LIST OF FIGURE Figure 2.1: Keynesian AS-AD model Figure 2.2: A tight monetary policy of traditional Keynesian ISILM model Figure 3.1: Economic growth- Source: IMF (2012) Figure 3.2: Inflation and real GDP growth rate- Source: IMF (2012) Figure 3.3: Interest rate in Vietnam - Source: State Bank of Vietnam and World Bank website (2012, accessed on November 10, 2012) Figure 4.1: Response of real output growth to money supply Figure 4.2: Response of inflation of the urban area, the rural area and all over of Vietnam to money supply Figure 4.3: Response of real output growth to money supply, and price level to money supply Figure 4.4: Response of domestic credit to money supply, price level to money supply, and price level to domestic credit LIST OF TABLE Table 4.1: Summary of data Table 4.2: Stationary tests for variables in level Table 4.3: Stationary tests for variables in percentage change Table 4.4: Granger causality Wald tests for the basic model with Real output growth, Price level of all over Vietnam, Money supply variables Table 4.5: Granger causality Wald tests for the basic model with variables of Real output growth, Price level of the urban area of Vietnam, Money supply Table 4.6: Granger causality Wald tests for the basic model with variables of Real output growth, Price level of the rural area of Vietnam, Money supply Table 4.7: Variance Decomposition for the basic model with variables of Real output growth, Price level of all over Vietnam, Money supply Table 4.8: Variance Decomposition for the basic model with variables of Real output growth, Price level of the urban area of Vietnam, Money supply Table 4.9: Variance Decomposition for the basic model with variables of Real output growth, Price level of the rural area of Vietnam, Money supply Table 4.10: Granger-causality tests for the extended model with variables of Real output growth, Price level of all over Vietnam, Money supply, and Lending rate Table 4.11: Variance Decomposition for the extended model with variables of Real output growth, Price level of all over Vietnam, Money supply, and Lending rate Table 4.12: Granger-causality tests for the extended model with variables of Real output growth, Price level of all over Vietnam, Money supply, and Domestic credit ' ,I \ • GROWTH DL_M2 DL_LR 34.09996 7.390252 3.505551 4 0.0000 0.1166 0.4770 All 57.55381 12 0.0000 Dependent variable: DL_M2 Excluded Chi-sq df Pro b GROWTH DL_CPI DL_LR 9.353273 4.129659 18.50970 4 0.0529 0.3887 0.0010 All 37.37084 12 0.0002 Dependent variable: DL_LR Excluded Chi-sq df Pro b GROWTH DL CPI DL-=:_M2 3.644364 9.964647 2.846564 4 0.4563 0.0410 0.5838 All 16.57860 12 0.1661 • EXTENDED MODEL WITH GROWTH, DL_CPI, DL_M2, DL_CREDIT VAR Granger Causality/Block Exogeneity Wald Tests Date: 12128/12 Time: 14:34 Sample: 86 Included observations: 81 Dependent variable: GROWTH Excluded Chi-sq df Prob DL_CPI DL_M2 DL_CREDIT 1.426420 1.729772 4.654106 4 0.8396 0.7853 0.3247 All 16.26399 12 0.1794 Dependent variable: DL_CPI Excluded Chi-sq df Pro b GROWTH DL_M2 DL_CREDIT 27.04369 7.614262 25.51142 4 0.0000 0.1068 0.0000 All 97.17867 12 0.0000 Dependent variable: DL_M2 Excluded Chi-sq df Prob GROWTH 4.737628 0.3153 - 78- \ DL CPI DL_CREDIT 6.752823 1.254841 4 0.1495 0.8690 All 16.17164 12 0.1835 Dependent variable: DL_CREDIT Excluded Chi-sq df Pro b GROWTH DL_CPI DL_M2 5.035541 8.238847 9.653270 4 0.2837 0.0832 0.0467 All 29.14043 12 0.0038 EXTENDED MODEL WITH GROWTH, DL_CPI, DL_M2, DL_E VAR Granger Causality/Block Exogeneity Wald Tests Date: 12/28/12 Time: 14:39 Sample: 86 Included observations: 81 Dependent variable: GROWTH ~ • Excluded Chi-sq df Pro b DL_CPI DL_M2 DL_E 2.260736 10.24651 1.160103 4 0.6879 0.0365 0.8846 All 12.17912 12 0.4314 Dependent variable: DL_CPI Excluded Chi-sq df Pro b GROWTH DL_M2 DL_E 38.73579 6.199364 3.300864 4 0.0000 0.1847 0.5088 All 57.18524 12 0.0000 Dependent variable: DL_M2 Excluded Chi-sq df Pro b GROWTH DL_CPI DL_E 4.184335 12.16883 4.913319 4 0.3816 0.0161 0.2963 All 20.66642 12 0.0555 Dependent variable: DL_E , Excluded Chi-sq df Prob GROWTH DL_CPI DL_M2 9.544021 14.48529 4.021488 4 0.0489 0.0059 0.4031 -79- All 26.31926 12 0.0097 BASIC MODEL WITH GROWTH, DL_CPI_UB, DL_M2 VAR Granger Causality/Block Exogeneity Wald Tests Date: 12/28/12 Time: 14:18 Sample: 86 Included observations: 81 Dependent variable: GROWTH Excluded Chi-sq df Prob DL_CPI_UB DL_M2 1.296537 9.356095 4 0.8620 0.0528 All 11.13396 0.1942 Dependent variable: DL_CPI_UB Excluded Chi-sq df Prob GROWTH DL_M2 31.36005 8.123065 4 0.0000 0.0872 All 43.08700 0.0000 Dependent variable: DL_M2 Excluded Chi-sq df Prob GROWTH DL_CPI_UB 5.484447 11.11974 4 0.2411 0.0253 All 17.26811 0.0274 BASIC MODEL WITH GROWTH, DL_CPI_RR, DL_M2 VAR Granger Causality/Block Exogeneity Wald Tests Date: 12/28/12 Time: 14:25 Sample: 86 Included observations: 81 Dependent variable: GROWTH Excluded Chi-sq df Pro b DL_CPI_RR DL_M2 1.897495 10.10236 4 0.7546 0.0387 All 11.82023 0.1594 Dependent variable: DL_CPI_RR Excluded Chi-sq df Pro b GROWTH 22.06079 0.0002 - 80- DL_M2 9.392540 0.0520 All 35.96664 0.0000 Dependent variable: DL_M2 Excluded Chi-sq df Pro b GROWTH DL_CPI_RR 6.150511 11.57344 4 0.1882 0.0208 All 17.75707 0.0231 - 81 - APPENDIX7 IMPULSE RESPONSE FUNCTIONS BASIC MODEL WITH GROWTH, DL_CPI, DL_M2 Response to Cholesky One S.D Innovations t S.E RespoMe of GROWTH to Dl_CPI Rwpcme of GRO\NTH to GROWTH Respor&e of GROWTH to OL._M2 ~r -, ~-. -, "10 10 -· V\> -./"· ·· - ·- -· \ -.:::>::::: ····· ··-·· ~r -, " ·10+,2 ,.,,, , ,, , ,, ,.,1·0, ,, ,.,,., , 1,.-M, " 10 -1o+-r2 ,.,,, , ,,.,,~1"o"'"'=,,.,-1'••1cr,-rl, ·10f-r2 ,,, , ,, , ,, ,.,,'="oro:, ,.,,.~1:c,-M, Response of Dl_CPI to DL_CPI •-h~r-r~~r-r~~r-r~ • 8 10 12 w 18 Response of DL_CPI to DL_M2 ·-•-h~r-r-,~r-r-,~r-r-,-J 18 Resporse d DL_M2 to GROIVTH 8 10 12 w 18 ·-•-h~r-r~ ,.,r-r~-r-r-r~ 18 8 10 12 14 RespoMe of DL_M2 to Response of DL_M2 to DL_CPI 18 18 DL_M2 \ \k , ~ -················ -1 • 10 12 14 18 18 I -1 +-r-2, ,., ,, , ,, , ,10""'"'1""2'1'•r:c,.-rl, W 12 14 16 18 EXTENDED MODEL WITH GROWTH, DL_CPI, DL_M2, DL_LR Response to Cholesky One S.D Innovations± S.E ~1p0n• of GROWTH to GROWTH Respon• of GROWTH to DL_CPI Reepon• of GROWTH to DL_LR Re1p0n• of GROWTH to DI _M2 Wr , 20r , 20,. , 20r , 10 10 10 10 /' -10+ ,2-,,~,, , .,, ,10, 1'2'1r,ro:,.-rl, R~nte of ~;};;\::;.:::::::.:::~.::· -1o+, , ,, , r-r.,.,.,., , , , , , ,:~ " a a to 12 '" 11 11 -1o +-:!2-r-,, ,-r,-r-r,-,.-,1o:-r-:1':"2•,:c:,-r:o:,.:-r-:1, OL_CPI to GROYt/TH ··-. -, • ·•r , •., , +,-,-,, , r-rr-r-,-,-,-r-rr-r-rl \~~~"\ ot '\""::-"-: -='-::::-==1 -.2 •+,2-,-,,rr-., ,- .~10_, ,,, , ,,.,.,'1"'1., ,111 R.lpOMB of I Retpon• Dl_M2 to GROWTH 10 12 14 HI 18 · - Rupon of Dl_LR to GROWTH ·2 +-r-2., ,.,., ,-,., ,-,-.-,:,, -,:,-r:.-;,., -,:,.crol, \ \ I 10 12 14 16 18 to DL_M2 10 12 14 16 18 Reapon• of DL._M2 to D _LR r-,~ -::· - - \~ -1 -2 +-r-2, ,.,, , , ,.,'7.:1o"-, ,.,,."-1.-r:~, R~on• or OL_M2 ~- of DL_M2 to DL_ CPI -2 +-r2 ,.,., ,.,""•""'7.10-.-,:12-. ,.:14-.-,:18-r:l, Re1p0n• ofDL._LRto OL._CPI 10,-,12:-r-1r4 r 1,-:8-r:118 • +-r , ,~, ,-,-ry ReiPC)n• of DL._LR to OL._M2 /~ - Respon• of DL._LR to DL._LR \ : \t::::::· - ';~ ~ ~ ~ -··~ · -2 + ,2.,,,., • -.,.,"'•o"',:-r-:1 ,-4.,,.-. :~, 10 12 18 18 ~+-r-,-,rr-rr•~-,-,crrrc., ,! - 82- -