Luận văn thạc sĩ UEH the effect of money growth on inflation in vietnam from 2004 to 2010

UNIVERSITY OF ECONOMICS

HO CHI MINH CITY

VIETNAM

INSTITUTE OF SOCIAL STUDIES

THE HAGUE

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

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CONTENTS

CHAPTER 1: INTRODUCTION ...................................................................................... !

1.1 PROBLEM STATEMENT ............................................................................................. 1

1.2 RESEARCH OBJECTIVES AND QUESTIONS ......................................................... .3

1.3 METHODOLOGY ........................................................................................................... 3

1.4 STRUCTURE OF THESIS ............................................................................................. 4

CHAPTER 2: LITERATURE REVIEW .......................................................................... 6

2.1 THEORETICAL LITERATURE ................................................................................... 6

2.1.1 INFLATION ................................................................................................................ 6

2.1.2 SOURCES OF INFLATION ....................................................................................... 7

Keynesian View ......................................................................................................... 7

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

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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

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CHAPTER 5: CONCLUSIONS AND POLICY IMPLICATION ................................. 73

5.1 CONCLUSIONS ............................................................................................................. 73

5.2 POLICY IMPLICATION ............................................................................................... 74

5.3 LIMITATION ................................................................................................................. 76

REFERENCES

APPENDIX

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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 9 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 .................................................... 9

Figure 2.2: Recessionary and Inflationary Gap .................................................................... 1 0

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

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•

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.

Consequently, an increase in money stock may lead to growth in aggregate demand and

positively affect the economy. On the other hand, high growth in money may reduce its

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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.

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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.

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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 1 presents the important of the thesis' findings and its objectives. It also briefly

presents the methodology is applied in the thesis.

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